No Fear
Checking out attitudes in the options world
By Jay Shartsis
Traders of a certain age will recall a popular investment book of yesteryear
quaintly titled Happiness Is a Stock That Doubles in a Year. An updated
edition might bear the title Happiness is a Stock That Doubles in 45
Seconds. Inspiration for the tome is generously provided by the myriad Nasdaq
shooting stars illuminating the firmament.
The great liftoff since the October 1999 low pushed the Nasdaq 100 (NDX)
from 2362 to 4549 on February 17. That's a brisk 93% in 17 weeks, and it's
getting some people downright nervous, with a few observers expecting an
equal and opposite reaction, or worse.
Last week, however, this column noted that analysts at Schaeffers Investment
Research had found open interest in NDX puts greatly outweighing open
interest in calls. But this hefty dose of pessimism may comfort the bulls. Chris
Johnson, the managing quantitative analyst at Schaeffers, reports that there are
now five times as many NDX puts open as calls (239,436 puts versus 48,336
calls). Last May, the reverse was apparent, with two days of call open interest
greater than put open interest, a ratio below 1.0. That display of option player
optimism resulted in a month-long decline in the NDX that began two weeks
later. Johnson says that the current 5.0 is in the top 12% of readings for the
NDX open interest ratio since its inception in March 1999.
Another window on trader psychology is to compare the largest cluster of call
open interest at a single strike to the largest concentration of puts. Bullish
markets tend to have the "peak" open interest residing in a put. That is the case
now for the NDX with the March 180 put having 28,446 contracts while the
biggest call cluster is only 1839 in the March 160 call.
Other short-term timing models,
however, are not as bullish so Johnson
concludes that a trading range can be
expected for the NDX in the near term
with long-term bullish projections. One
of those other not-so-hot indicators is the
venerable put/call ratio on the CBOE. It
has recently spent a very long time in the
bearish mode, an amazing 42
consecutive days of heavy call buying,
according to Jim Stack, editor of
Investech Research. Stack notes that
this has never happened over the past 16
years. Worth noting, too, is the curious
fact that recent market plunges have not
seen any big shift to the put side by option players. Even on the biggest down
days, the CBOE equity put/call ratio has not manifested anything like real fear.
The implication is, of course, that a far larger decline will be necessary to get
the put buyers active again. Larry Connors of Tradingmarkets.com is
concerned about the recent behavior of the VIX. He says that over the last two
years when the market has corrected more than 10% the VIX has reached the
low to mid-30s. Such readings are reflections of OEX puts jumping up and have
been coincident with market bottoms. This time, Connors says, since the VIX is
only around 26 it may mean more downside is coming. Meyer Eisner, the chief
option strategist at 21st Century Options Hotline, comments that looking for a
"magic number" like VIX 30 works until it breaks 50, as it did last October. He
uses big VIX increases to short inflated option premiums that accompany an
elevated VIX level.
Since "momentum investing" is now the national pastime, here are some tips on
"how to" from strategist Larry McMillan.
1.) A breakout above previous tops is good. A breakout above multiple previous
tops, at about the same level, is better.
2.) Look for heavy option volume on the breakout at least double the normal
option volume.
3.) Don't chase the initial breakout. Wait for a pullback toward the breakout
level, which should provide some technical support.
Recent candidates that meet the three criteria were Network Appliance, Corr
Therapeutics, Nortel, Portal Software, Cell Pathways Cabletron and a lot
more, Larry writes.
JAY SHARTSIS is director of option trading at R. F. Lafferty & Co. in New York City.
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