Put/Call Ratios - Archived Nov 11, 2000

Here are my observations on the equities Put/Call ratio.

• As long as the retail investors will have the reputation to be wrong, this will be a good contrarian indicator.
• I prefer another rationale, based on the amount of liquidity these investors have.
  When the investors have positionned themselves in their accounts, long or short, comes a point
  at which they don't have sufficient buying power left to take other positions.
  At that time, these investors will look for Dollar amount leverage, the longs will consider buying calls, the shorts consider buying puts. On margin.
  
  Comes the time at which all available buying power or margin has been exhausted.
  Supply and demand rules this market as any other.
  So if more calls are bought, there is no money left to bid-up on the shares, and the prices go down.
  Conversely, when the volume in put increases, this is a sign that the shorts ran out of power, all their positions taken on the short side.
  No more offers to sell, meaning that the buy side has the upper hand: more demand. Prices go up.

There are 3 interpretations of the equities PCR

• one, short term, based on a 10 days moving average and triggering levels of 0.5 and 0.4.
  IMHO, this systems shoots too many false alarms.
• The second interpretation is based on a 21 days moving average and triggering levels of 0.4 and 0.55.
  This interpretation does not take into account extreme readings or sideways markets.
• Schaeffer and McMillan observed that the trend reversal of the moving averages give the proper signal.
  I finally endorse this view.
• Oct 02: non-pros are becoming overly bearish. Coventional wisdow says that investors are correct when recognizing a trend, but that they are wrong on both ends.
• Oct 10: curve of the moving averages on the index PCR are flattening , equities PCR at unusual (unsustainable?) high levels, but still no peak in view.
• Oct 16: equities PCR have reversed, indexes PCR printed lower than Fri: still waiting for both to have reversed in order to have he true signal.
• Oct 19: moving averages have reversed.
• Oct 30: equities PCR are not yet in a downward trend, all indexes PCR are down again: this spells trouble.
• Nov 10: since Oct 25, the all indexes PCR is not directional again. Equities PCR still is in a downtrend. Both PCR must diverge in order to give a signal.
• Nov 18: both PCR diverging again (confirming eachother). Apparently indicating that the market is bound for a lower low. Still waiting for a clear trend.

Next indications I will watch:

• It is the first time I have seen the equities PCR at such high levels. Even if the trend has reversed, put buying is still at high levels.
• Indication seems to be that the investors are buying less puts. Mark-up phase.
• The .55 level could suggest that investors will start to buy more calls: this would then suggest that investors have run out of dry powder, using calls as a surrogate for stocks. Wrong doing. Distribution phase.
• The closer we would get to .4, would signal the exhaustion of buying power.
• The all indexes PCR reverses trend before the equities PCR and are a better signal of sell-off and accumulation phases.

• The all indexes PCR here above is NOT contrarian:
  it is a good practice to hedge one's portfolio.
  Institutions do so: they buy puts to protect their profits.
  I use a level of 1.1 as a normal PCR.(It should be neutral at 1 for 1 plus annual interest and dividends added.)
  This would roughly hedge the ports at a "fair value".

Take this with a "ton" of salt, I only start observind these PCR's.

Litterature documents another CBOE PCR:

• the CBOE all products PCR, or the total of both all indexes and all equities.
  This one is considered bullish when above 0.7, and bearish when below 0.4, filtered on a 21 DMA.
  Best explained by Steve Achelis.
  For an updated chart.
• As you can observe on the last months, this index is not working anylonger.

Further readings:

• Bernie Schaeffer: The Option Advisor: A Look at the Put-Call Ratio Oct 18 1999 and Revisiting the Put-Call Ratio Jun 19 2000 on the late cnbc.com site.
• Larry Mc Millan: Optionstrategist: The Put-Call Ratio analysis learning leaning towards PCR on individual stocks.

Past articles

• maintained by disu on SI thread TidBits

Data on PCR

• get them half-hourlyfrom the exchange at the CBOE. Look also at the all products >total open-interest.
• equities PCR and indexes PCR are AFAIK propietary statistics. Quote.com provides these real-time on the site, or at Astrikos.

Related topics:

• Market Gauge's has several indicators they follow on the site: "Market Analysis", then "User's guide index". Indicators I like to follow are:
  Market Gauge has revamped it's site.Worth a look.
• The CBOE Volatility Index - VIX™ , and historical data,
• the Commitment of Traders report COT, better viewed in Laverne Olney's spreadsheet.
• and the other market indexes the SI MITA thread follows,
• as the RYDEX funds total assets,
• the MaxPain™ theory,
• the peak open/interest, introduced by OptionInvestor.com).

I do not support poll's or sentiment analysis as the AAII (American Association of Individual Investors) index ratio, nor Martin Zweig's analyze of the ad's in the Barrons, or other Investors Intelligence data.
Analysis of contrarian indicators should, imho, concentrate on where the money is invested in, not what people say they feel.
Other contrarian analysis is more aimed towards individual shares, as reclassment of shares, buybacks, insider trading, volatility change... This is another story.