Rise in options gauges hint at market bottom soon
Monday May 17, 4:39 pm ET
By Doris Frankel
CHICAGO, May 17 (Reuters) - The Chicago Board Options Exchange's Market Volatility Index (CBOE:^VIX - News) and another popular contrarian gauge, the put/call ratio, are moving in tandem and popped up on Monday, indicating mounting pessimism among traders within days before Friday's May options expiration.
The rises in both indicators have prompted some analysts to suggest that stocks may be ready to halt their steep declines as investors use put options to manage their stock market risks.
"We need a number of indicators to come together to have any real predictive value. The VIX can measure extremes of fear. You can use it as a sentiment indicator along with the put/call ratio which is also rising," said Richard Croft, president of Toronto-based Croft Financial Group. "Together, this may indicate a bottoming process in the market."
Based on real-time Standard & Poor's 500 index options, the VIX is designed to reflect investors' consensus view of stock market volatility over the next 30 days.
A low VIX signals a market complacent about current stock levels and not looking for any huge price swings while a rising VIX indicates a turn away from complacency to a state of nervousness usually triggered by a stock market decline.
Instability in Iraq, a sharp increase in oil prices and the prospect of rising U.S. interest rates have made investors anxious as they snap up short-term index puts on the Standard & Poor's 500 to protect their stock portfolios.
As a result, the options indicator known as the VIX or Wall Street's fear gauge, jumped to an intraday peak of 20.45 on Monday, slightly above the May 12 high of 20.41.
Last Wednesday was a key reversal day for the S&P 500 index. The VIX ended at 18.14 when U.S. blue chips rose in a late-day rally as investors set aside worries about geopolitical tensions and higher interest rates .
Late Monday the VIX stood at 19.96 as the S&P 500 held onto its 200-day day moving average of around 1079.75. "We view that as a short-term positive, which means that the market may be in a bottoming area," said Elliot Spar, options market strategist with Ryan Beck & Co.
Another gauge that reflects options players' sentiment is the put/call ratio, a contrarian indicator which is derived from the traded volume of puts relative to calls.
A put/call ratio is the volume of all puts divided by the tally of calls traded on a given day.
Investors who want to protect their portfolios will buy puts, which give the right to sell a security at a preset price in the future. An equity call is an option similar to a put, but it conveys the right to buy a stock.
"The all exchange equity put/call ratio early on Monday had a reading of 0.95, showing that 95 puts were traded for every 100 calls," Spar said. "A number of 0.90 or higher for two days back-to-back would be another contra-indicator that the market is ready for a relief rally."
OPTIONS EXPIRY A FACTOR
Traders face more uncertainty with the expiration of May options on Friday when increased volatility may occur as players unwind May positions and roll them over into June and future months to manage their equity exposure.
"By Friday, there is a good chance there will be a large amount of stock to buy between Monday and Thursday's close. Options traders who are short puts will have to unwind their positions in essence by buying back stock," said John Jacobs, president of Jacobs & Co., an investment adviser. |
