** Put Call Ratio Article **
New York, Aug. 21 (Bloomberg) -- Options investors increasingly are speculating that stocks will extend their slump in coming weeks, by one market benchmark -- and their pessimism could be good news for equities.
That's the prediction of analysts who watch options buying to keep track of what the majority of investors do -- just so they can go the other way. These contrary-minded experts see pessimism as good for stocks, because it implies that investors are accumulating cash as they wait for the market to improve.
Put/call ratios calculated by the Chicago Board Options Exchange show that investors bought relatively more ''put'' options than ''call'' options in recent days -- the most since 1995, by one measure.
''On a contrarian basis, we have the makings of a big move to the upside,'' said Michael Schwartz, chief options strategist at Oppenheimer & Co.
Puts give the right to sell a stock or index at a specified price by a specific date, so buyers make money when the underlying security falls. Calls are the opposite: a bet that the security will gain.
The put/call ratio is simply put volume divided by call volume. Investors who watch the ratios say a value greater than 1 signals that most speculators are pessimistic about the market and expect stocks to fall. That value can be used as a signal to buy.
Values less than 1 indicate that optimism is the ruling sentiment, suggesting that investors may be fully invested and have little cash on hand to propel stocks higher. The big market declines in October 1987 and October 1997, as well as the drop on Aug. 4 of this year, all were preceded by rising optimism that was reflected in call buying.
Abundant Pessimism
Just as optimism was overabundant in late July this year, before the market began a monthlong decline, pessimism is now getting out of hand, contrarians say.
The CBOE calculates a number of put/call ratios using indexes and equities, as well as a composite of both.
Each analyst favors one particular ratio and has their own interpretation of the critical value at which sentiment shifts from bearish to bullish. Merrill Lynch & Co. chief market analyst Richard McCabe, for example, follows the CBOE's Put/Call Composite ratio using a 25-day average.
In the 10 days before the 554-point, or 7.2 percent, decline of the Dow Jones Industrial Average on Oct. 27 last year, the Composite Put/Call ratio traded at an average of 0.66 on the CBOE, according to exchange data -- a sign to McCabe that speculators buying options were bullish.
Similarly, in the seven days before Oct. 19, 1987, when the Dow average fell 508 points, or 23 percent, the composite ratio averaged 0.92, indicating that options investors were bullish.
This year, when the Dow peaked on July 17, the composite put/call ratio was a low 0.56. The index has since lost almost 9 percent, at one point falling 10 percent and meeting the accepted definition of a ''correction.''
Today, the composite put/call index closed at 1.20, its highest level since March 22, 1995. The Dow rose 12 percent in the three months that followed that 1995 peak. It went on to gain 33 percent for the year, its best performance in two decades.
''The numbers are building up, indicating there is more pessimism than caution -- which says the market has made a short- term bottom,'' McCabe said.
Cash to Spend
Another reason that puts are positive for the stock market: many investors use them as hedges, or protection against declines, when they buy stocks. That in itself indicates that there's a certain amount of buying going on.
''The hedge protects them,'' said Scott Fullman, chief options strategist with Swiss American Securities Inc. Still, ''people are not fully invested and still have cash.''
Fullman uses the put/call ratio based on the Standard & Poor's 100 index as an indicator of market sentiment. ''When the indicator is above 1.2, people are nervous,'' he said. ''They are not fully invested,'' and have money to put into the market.
The S&P 100 ratio rose to almost 2.6 during trading on Monday. It averaged 1.2450 for the past eight sessions.
For the contrarians, at least, that's good news. |
