Sunday, August 23, 2009

The Put to Call Ratio

is at an extreme level currently when using the Chicago Board of Options Equity Put to Call Ratio ($CPCE). The current spike can be put into perspective when comparing it to previous spikes over the past 3 years. Now, no one indicator is reliable in and of itself, but the put to call ratio (i.e. ratio of the number of equity puts/bearish bets bought divided by the number of equity calls/bullish bets bought) is a reasonable measure of sentiment.

Here is the raw plot of the $CPCE, which is noisy, compared to the S&P 500 over the past 3 years using a daily chart that contains a plot of the data for both:

This is the lowest spike in the $CPCE in more than 3 years! To make the $CPCE plot a little less noisy, here is the same 3 year daily chart but instead of plotting the $CPCE versus the S&P 500, following is a plot of the 8 day exponential moving average of the $CPCE versus the S&P 500 to show the statistically extreme nature of the short-term spike in call option buying relative to put buying:

The comparison to mid-July of 2007 seems reasonable to me. A spike down for a few weeks followed by a brief rally to re-test the highs in the general market averages would allow for some deterioration in breadth (90% of stocks are above their 200 day moving average right now!) and a significant momentum (and breadth) divergence on the price re-test to set up another fall disaster.

Wikinvest Wire