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Behind the Put/Call Ratio


Many of you probably monitor some deviation of a put/call ratio during the day. It is easy enough to view, as the data is made available for free from the CBOE. I've received quite a few emails about the high ratio we're seeing so far today, with the CBOE total put/call ratio showing an intraday reading over 1.0 (meaning there have been more puts traded than calls). This is unusual for an "up" day and may suggest that traders are betting on this little recovery to fail. From a contrarian standpoint, that's bullish, since options traders are often wrong when they lean on one side too far.

However, if we dig a little deeper and look at the components of the ratio, the bullish spin begins to wear thin. For example, so far this morning the equity-only put/call ratio is 0.88 (this does not include index options). If it stayed this high by the close, it would be more than a standard deviation above its mean during this bear market. However, options on the QQQ tracking stock are included in this ratio, even though they are essentially an index option and not an equity option (for all intents and purposes). If we back out options traded on the QQQ, then the CBOE equity p/c ratio drops to about 0.62 -- right in the middle of its range. This is neither particularly bullish nor bearish.

As the chart below illustrates, option volume on the QQQs has skewed the put/call ratios with increasing frequency:

It has gotten to the point now where QQQ options skew the equity put/call ratio to a great extent about once every three or four days. For this reason, I prefer to monitor the equity p/c ratio without QQQ options included. When that is done, the current 10-day average is at 0.56 -- at the low end of its range, and similar to where is has been at many of the intermediate-term highs over the past two years.

Also, the OEX (S&P 100 Index) put/call ratio is running well over 1.0 today. As I'll discuss at some point soon, OEX traders are infinitely better market timers than are equity option traders, and for the most part their activity should NOT be considered in a contrarian manner. A high OEX p/c ratio tends to be bearish for the market, while a low OEX p/c ratio tends to be bullish -- especially when it is sustained over a week or two. For the past week, OEX traders have been concentrating on puts, and to an extent that has indicated trouble for the market over the last decade.

Therefore, while the headline put/call figure appears to be bullish for the market (too much pessimism), when we dig a little deeper, it appears to be neutral at best, and probably even bearish longer-term. This is only one indicator, and not nearly enough to base a trading decision off of, but I thought I would point out the danger of relying on the headline number from an oft-cited sentiment measure.
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