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Put/Call ratio



The high put/call ratio of the past few days has been getting quite a bit of attention. On Monday, the CBOE total put/call ratio - the most widely-quoted ratio - reached 1.21. Historically, that is in the top 10 since 1995, but when put into a relative context (such as its deviation from its 200-day moving average), it doesn't even make the top 50. On Tuesday, it was still high at .90 and yesterday it came in at 1.08. The three-day average of these readings is 1.06, which is one of the highest in 8 years. This type of activity has been quite bullish in the past and would suggest higher market prices are in store.

However, I believe it would be a mistake to take these figures at face value. Increasingly, QQQ options are becoming a major factor. Just a year ago, QQQ put volume rarely exceeded 20% of total equity put volume. Since the beginning of this year, those same options accounted for over 30% on a regular basis and have even gone well above 40%. For example, yesterday the CBOE shows 294,945 equity put options being traded. Of those, 118,348 were QQQ options, which is 40% of the total.

If we take QQQ options out of the loop, and recalculate the figures in the first paragraph, the three-day average of the put/call ratio would drop from 1.06 to 0.89. I've discussed before how QQQ has become an institutional product, and its options are no different. The QQQ put/call ratio, to me, is no better than random at forecasting future market direction - if anything, spikes higher in that ratio have coincided more with market peaks than market troughs. Therefore, I believe it is constructive to remove those options when looking at put/call ratios.

The chart below shows a 10-day average of the equity put/call ratio with QQQ options removed, surrounded by six-month Bollinger Bands (a relative measure of extremes). We can see that currently, we are just beginning to recover from a sell signal, which will take a week at the very least to wear off.

The headline put/call numbers are showing too much fear among traders and from a contrarian perspective that appears bullish. We may get a short-term rise here as low-volume conditions and positive pre-holiday seasonality (especially tomorrow) assert themselves. But if you're looking for a longer-term long trade based primarily off of high put/call readings, then you may want to look a little further behind the headline numbers.

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