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Lots of Calls Could Lead to a Fall

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Recent market activity has tampered with the safety net.

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With September options set to expire this Friday, it's time to take a look at the configuration of open interest to see if we can glean what, if any, influence it will have on the market.

In looking at the popular index products, such as the S&P 500 Index and its ETF offspring the Spyder Trust (SPY), the first thing of note is there's a tremendous imbalance in open interest between near-the-money puts and calls.

In the SPX options, the 1050 strike has 74,000 calls still open to just 23,000 puts, the 1060 line has 16,000 calls and just 200 puts.

In the Spyder Trust, the $104 strike has 112,000 calls and 50,000 puts, the $105 strike has 114,000 contracts and 45,000 calls, and the $106 line has 100,000 calls to just 20,000 puts.

So all told, the near-the-money strikes have some 337,000 calls to just 120,000 puts -- or nearly triple the number of calls.

Some of this imbalance is likely the result of the recent rally, which pushed the bulk of the puts out of the money, but that doesn't seem to completely account for this unusual configuration.

Typically, in the Spyder, there's a greater number of puts than calls open as investors and money managers use the Spyder puts to gain broad portfolio protection.

Yet this month, the shift in which there are more puts than calls doesn't occur until you drop down to the $100 strike, and even then it simply becomes evenly balanced.

One explanation could be that people are choosing to use buy-writes, that is, sell calls against their long positions as means of hedge rather than buy put protection.

The advantage of the buy-write is it allows you take in some premium and benefits from time decay. The disadvantage is that it caps your upside profit potential and only provides a minimum of downside protection.

One potential outcome of this option configuration is that if the market somehow turns lower -- something it hasn't done in nine consecutive days, which may also explain the disregard for buying put protection -- there will not be the usual safety net in place that allows people to aggressively buy dips.

Of course, there are a host of factors at work, but in isolation, this preponderance of call options can be taken as a contrary indicator -- and therefore has bearish implications.

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No positions in stocks mentioned.

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