Trading strategy based on sentiment analysis, from Optioninvestor.com:
Market Sentiment, Sunday, 10/24/99
Great Expectations III!
Below is an updated list of equities (that should be reporting their earnings this next week) and our Pinnacle Index for those particular stocks. The Pinnacle Index is a proprietary product that determines current market sentiment and expectations for underlying equities and indexes, which is based upon speculation in the option markets. Also included are their expected earnings, the infamous whisper number (if available), and their estimated earnings release date.
What we look for are liquid stocks/options that garner a lot of interest from the investment community. Most of the issues are high tech, and are thus more aggressive. We then filter out many of the equities, only to show stocks with excessive optimism or pessimism. From a contrarian standpoint (a high number is a good indication of extreme optimism, and a low number is a good indication of extreme pessimism) you should buy when its low, and sell when its high. Last quarter, we highlighted some stocks with a Pinnacle Index that were stratospheric (as high as the upper 20's). Needless to say, these stocks had so much pent-up enthusiasm, that after their earnings, they tanked. It is the old adage, buy the rumor - sell the news. There were also numerous companies with a Pinnacle Index less than one. However, once these companies came out with their bad quarter, the stocks rallied due to the oversupply of pessimism.
If your favorite stock is not listed, the most common reasons are: 1) there are no options traded on the underlying equity 2) lack of interest by option speculators in the security 3) lack of quality information 4) company already pre-released 5) insufficient data. Also, as we get closer to the heart of earnings season, the list will expand dramatically to reflect companies whose earnings are due out shortly.
Company Symbol Pinnacle Expected Whisper#: Estimated
Index(PI): Earnings: Date*:
AT&T T 2.61 +.53 +.54 10/25
Compaq Computer CPQ 1.32 +.05 +.06 10/26
Pixar PIXR 2.44 +.31 +.32 10/25
US Web USWB 4.53 +.13 +.15 10/25
Walt Disney DIS 0.80 +.11 +.11 10/25
BMC Software BMCS 0.50 +.41 +.43 10/25
Lucent Tech LU 0.69 +.29 +.31 10/26
Ebay EBAY 2.53 +.01 +.02 10/26
Priceline.com PCLN 2.74 -.10 -.09 10/26
Nortel Networks NT 6.88 +.26 +.28 10/26
Ameritrade AMTD 1.46 -.05 -.04 10/27
Qwest Comm. QWST 4.28 +.03 +.04 10/27
Amazon.com AMZN 2.56 -.28 -.27 10/27
Go2Net GNET 1.73 +.06 +.08 10/28
Infoseek SEEK 3.63 -.42 -.39 10/28
Infospace INSP 4.31 -.03 -.01 10/28
JDS Uniphase JDSU 12.80 +.25 +.27 10/28
Worldcom WCOM 1.90 +.53 +.53 10/28
Network Solut. NSOL 1.35 +.18 +.19 10/28
Last week we mentioned that Microsoft had very low expectations going into earnings. As such, they executed on their quarter, reported good numbers, the stock took a nice pop, and shareholders were happy. This was a very good example of using sentiment analysis for a trade, but the other part of the equation is execution by the company. They have to execute on their earnings (and meet the whisper number), and they need to avoid making negative comments about the future. As such, many people expected MSFT to either miss, or make negative comments about the future (Y2K slowdown?), but this didn't happen and the stock jumped.
On the other end of the spectrum, we mentioned that IBM had low expectations. Now IBM did have a +7 dollar run into numbers after we mentioned it, but we all know the rest of the story. They couldn't execute on their quarter, missed the whisper by 3 cents, made Y2K comments, and got crushed. This was a good example of why a stock had such low sentiment, because they deserved it. Obviously, somebody knew the problems of Big Blue, and profited handsomely on the puts or shorts. That is why we like to show the expected earnings and whisper number, so you know as an investor, know how high the expectation bar is set. In IBM's case, the bar was set low, and they came in lower.
Other low sentiment stocks that we mentioned (last Sunday) that had a good week was Microsoft, Ericcson, Exodus, Compuware, Coca-Cola, and Xilinx.
Low expectation stocks for this week would include: Worldcom, Network Solutions, Ameritrade, Compaq, Disney, BMC Software, Lucent Tech, Ebay, Go2Net, and Amazon.
High expectation stocks for this week would include Nortel Networks, US Web, and JDS Uniphase. Have a good trading week.
BULLISH Signs:
Pessimism on Earnings:
We should see a solid third quarter from many companies, yet their stock prices do not reflect this upside potential.
Investor Intelligence:
As a contrarian indicator, the amount of Bullish investors is at a recent low, and bearish investors is at a recent high.
Volatility Index:
The VIX is below the 25 benchmark, and continues to prove that 32-33 is a great buying opportunity. However, it is currently getting close to the point where the market failed before, so be careful.
Mixed Signs: None.
BEARISH Signs:
Interest Rates:
The yield on the 30-yr Treasury is breaking new highs, and will need to see a nice rally before stocks can advance back to highs.
Miscellaneous Uncertainty:
Y2K, inflation, higher interest rates, slowing corporate earnings, earthquakes, U.S. Dollar uncertainty, are all leading to an abundance of uncertainty for professionals and investors alike.
Advance/Decline Line:
The A/D line continues to be poor and is getting worse.
X-Factor:
Currently, good news is not rewarded very well, while negative news or even rumors will destroy a stock. We have witnessed this these last couple of weeks with issues such as IBM, Lexmark, HI/FN, Abercrombie & Fitch, and Unisys.
Russell 2000 & S&P 500:
The RUT and SPX are still very weak, with both breaking support levels.
OTM Call Analysis
As we move closer to the November expiration cycle, Pinnacle is tracking the level of call buying (OTM) between 690-780 among option speculators. As we have been documenting, excessive out-of-the- money (OTM) call may serve as overhead resistance.
November Expiration Cycle
OEX OTM Call Analysis (Open Interest November 680-780)
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Date Open Interest Change % Alert
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Friday, October 15 39,072 -
Friday, October 22 61,250 +56.8%
The Power of Sentiment Analysis
It has often been said that the crowd is right during the
market trends but wrong at both ends. Measuring and
evaluating the sentiment of the crowd, therefore, can give
savvy option traders a decided edge.
Pinnacle Index
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OEX Friday Tues Thurs
Benchmark (10/22) (10/26) (10/28)
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Overhead Resistance (685-700) 2.32
OEX Close 685.63
Underlying Support (660-680) 1.28
Underlying Support (630-650) 12.66
Average ratings:
Resistance levels 2.0 / Support Levels .5
What the Pinnacle Index is telling us:
Based on 10/22, both overhead resistance and underlying support are
light, which means we can easily rally 15 points just as easily as fall
15 points. However, should the market drop, we show great support at
OEX 630-650.
Put/Call Ratio
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Friday Tues Thurs
Strike/Contracts (10/22) (10/26) (10/28)
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CBOE Total P/C Ratio .69
CBOE Equity P/C Ratio .46
OEX P/C Ratio 1.67
Peak Open Interest (OEX)
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Friday Tues Thurs
Strike/Contracts (10/22) (10/26) (10/28)
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Puts 640 / 11,789
Calls 690 / 7,562
Put/Call Ratio 1.56
Market Volatility Index (VIX)
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Major
Date Turning Point VIX
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October 97 Bottom 54.60
July 20, 1998 Top 16.88
October 8, 1998 Bottom 60.63
January 11, 1998 Top 26.38
March 4, 1999 Bottom 28.15
May 14, 1999 Top 25.01
July 16, 1999 Top 18.13
August 5, 1999 Bottom 32.12
October 15, 1999 Bottom? 32.06
October 22, 1999 22.89
Investors Intelligence Survey
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Major Percent Percent
Date Turning Point Bullish Bearish
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October 97 Bottom 22.0 48.3
July 20, 1998 Top 52.0 24.0
October 8, 1998 Bottom 38.5 42.7
January 11, 1999 Top 58.3 30.0
March 4, 1999 Bottom 49.1 32.5
Oct. 20, 1999 41.0 38.5
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