What the small guy is up to
Below, John states that what he finds useful is trying to determine what type of attitude the retail investor has towards the market. One of the best ways to see this is by observing what type of derivatives they are trading. I don't care about lukewarm emotions - I want to see extremes of fear and hope. What better place to see those emotions at work than the most leveraged instruments available?
Fortunately, tools are available for us to observe this behavior. The great majority of casual sentiment observers look at the CBOE put/call ratios, which are only a part of the entire options market. The CBOE clears about 25% of all equity options contracts, which is less than the 30% now commanded by the electronic ISE exchange. If we branch out and look at all options exchanges (not just the CBOE), and narrow our search down to only the smallest of trades (pure retail trades of under 10 contracts), and narrow that down even further to trades that were bought to open, we can get an excellent read on what the small retail trader is up to.
The chart below shows the equity put/call ratio for trades under 10 contracts. The average premium per contract here is about $190, so we're talking a total value on the trades of between $200 - $2000. You can't get much more retail than that. Also, these puts and calls were only bought to open, not sold to open, which can skew the determination of whether the trader is bullish or bearish. There is really only one reason why a small trader buys a call - because he feels the stock is going up. He buys a put because he thinks the stock is going down. This is about as clear a read on small trader behavior as you're going to get, and as you can see below, these small frys have come off their most bullish readings (i.e. low put/call ratio) over the past couple of months, but are still nowhere near the levels of pessimism seen at the market lows in July and October 2002 and March of this year.
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