Too Much Market Love Worries Options Pros
By Brian Louis
Staff Reporter
8/21/00 1:10 PM ET
Watching the stock market lately has been akin to observing the recent Republican and Democratic party conventions: All goodwill, love and optimism.
Volatility Index
Today % Change
19.81 +2.01
Source: ILX
Those positive vibes in the market have had some market participants concerned for a while now, particularly those of the contrarian school of thought. Regardless, stocks overall have continued to move higher despite the warning flags in some sentiment indicators.
To contrarian investors, who believe strong sentiment in one direction is a signal that a cycle is ending and that a stock or sector will soon reverse course, the overall glowing view of stocks right now strikes a cautionary note.
Put/Call Ratio
Today (Noon) Previous Close
0.38 0.41
Source: ILX
The general feeling in the market for a while has been that the Federal Open Market Committee will not make a move regarding interest rates when it meets Tuesday for a one-day get-together.
Jordan Kahn, of Kahn Asset Management, said that in days preceding FOMC meetings over the last year, regardless of what the panel did or did not do, the moves in the market have generally been up.
For the overall market, Kahn cautioned that sentiment is too bullish right now, which will make it harder for stocks to make a meaningful upside move. He noted that recently the Chicago Board Options Exchange equity put/call ratio has been hovering around 0.50, which isn't overly pessimistic.
Kahn noted that strong upside moves usually come from higher readings on the put/call ratio, when it reflects more fear in the market. Kahn, however, did say that none of that is to say that the market can't move higher.
Kahn also pointed to the low levels in the CBOE Volatility Index, which was at about 19.60 during an interview with him Monday morning. He said that while the VIX, which traders use as a gauge of anxiety in the market, isn't a great market timing device, it's a good warning sign, and its current level has him starting to be concerned.
He said that if the VIX fell to the 18 level, it could be considered dangerous. The VIX rises when put option buying increases on options on the S&P 100, or OEX. A put option gives the purchaser the right but not the obligation to sell a security for a specified price at a certain time.
For contrarians, low readings on the VIX are bearish, while high readings are bullish. During the April selloff, the VIX spiked as high as 41.53.
The VIX on Monday hit a 52-week intraday low when it bottomed at 19.41.
Some pros warn, however, that the VIX has fallen out of favor. This is in part because volume in OEX options has declined significantly over the past few years, suggesting to many that the VIX may not be as reliable a sentiment indicator as it used to be.
Meanwhile, on a positive note for the market, Kahn said that the sideways action in the market has been healthy this summer as the trading range has helped earnings catch up to stock prices, particularly for tech stocks.
Kahn said a lot of what he's been doing lately has been selling covered calls, specifically front-month options (That strategy involves selling call options against a stock position to take in the options' premium) on stocks that have had big pops.
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