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Put-Call Extreme Not What it Seems?

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Now you're just making excuses!

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Most sentiment indicators don't see the light of day (in terms of media mentions) unless they are at an historic extreme. While those extremes may not mean anything whatsoever, it at least makes good press.
One of the indicators I've seen noted again and again this week is the total put/call ratio from the Chicago Board Options Exchange. After seeing an unprecedented (in recent times) string of 9 consecutive days with more put options traded than call options, the immediate reaction was that this was a sign of extreme pessimism among investors, and a sure sign of a market bottom.
Typically I would be one of those noting the bullish implications of this. But it's not quite what it appears, I'm afraid. Much of the recent volume has been concentrated in index options, not equity options. That might seem like a minor difference, but it's not…index option activity is NOT a good contrary indicator.
Don't take my word for it, let's just look at the facts. Much of the index option volume (usually about half) comes from QQQQ, OEX and SPX options. So let's just strip out those three series and plot the 10-day average of that p/c ratio against the market.
The little red arrows highlight others times it has become as extreme as it is now. Doesn't exactly look like a roaring buy signal, does it? In fact, when this index p/c ratio hits this kind of a level, the S&P 500 has actually under-performed a random return by an average of 0.6% over the next 10 trading days.
This is the reason I am hesitant about reading too much into the recent high put/call readings. Digging a little deeper into the headline numbers shows that it might not necessarily be an indication of outright panic from the average investor that some media outlets are making it out to be.
Some of the other option gauges I follow are hinting that we're getting close to seeing some excessive concern out there. But they're not quite extreme yet - certainly not on an historical basis like the total put/call ratio – and have a ways to go before they would confirm the "panic" evident in the headline p/c number.
No positions in stocks mentioned.

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