GTF,
I don't want to put words in anybody's mouth, but when Greg said he would like to see the put/call "a little higher", what he likely meant was that the equity put/call ratio still does not adequately mirror the horrible technical and fundamental factors in the market, and until it does, a reversal is unlikely. Market reversals are usually characterized by a sharp discrepancy between option speculator sentiment and the market condition. That is, at market tops there are usually very low put/call ratios (indicating excessive bullishness), while at market bottoms there are usually very high put/call ratios (indicating excessive bearishness). This is not at all as simple as it might seem at first glance.
There is no one "put/call" ratio. The put/call can be expressed in various ways, and can be expressed relative to an individual stock, futures, or commodities contract, or an index such as the semiconductor index or QQQ, or to the market as a whole. Also, it can be expressed in terms of day to day "instantaneous" readings (based, for example, on that day's transactions and new contracts created or open conracts), or as the moving average (e.g., 10 week) of the put/call. Furthermore, there are different ways to calculate a put/call, and they have different significance as well. You can, for example, calulate the put/call based on the front month, or front 3 months' open interest. The open interest is just the number of outstanding contracts, which have been neither exercised nor closed. Or, you can calculate the put/call from the number of new contracts entered into, which is sometimes more relevant, particularly if there has been a big change recently in this figure; many of the open contracts for any particular stock were entered into many months or even years prior, at a time when market conditions may have been much different than at present, and so these should sometimes be discounted to some extent, particulary if they are discordant with recent options activity.
I like to use the moving average for the put/call ratio for the market as a whole, or QQQ. Then, on an individual stock basis, I compare the overall put/call to the broader put/calls, looking for big discrepancies. This is similar to one of the premises that I used to look at RIMM as a possible short; RIMM has a P/E of 1200 or so, clearly way discordant from the market environment in which it trades, so either the market valuation as a whole must regress upwards towards RIMM, or RIMM's valuation must regress downward toward the market average, or both. I submit that it is far more likely that RIMM will be brought into line with the market, rather than the market being brought into accordance with RIMM, and this is one of the reasons I am short RIMM.
And similarly, the more an equity put/call diverges from the technical, fundamental, and market realities, the more powerful the contrarian indicator it becomes: high put/calls tend to be bullish, and low put/calls tend to be bearish.
But this cannot be evaluated properly in reference to any absolute number alone, such as the overall equity put/call ratio. In addition, you sometimes should look at the put/call in reference to the history of the put/call ratio for that particular stock. If there is a sudden increase or decrease in the put/call to historical extreme levels for that stock, then the current put/call becomes a more powerful indicator, partly because of the tendency for such indicators to regress back towards their "mean" values (i.e., the 10 week or 20 week moving average of the put/call), and the fact that the more extreme the value, the stronger the tendency to regress. This is not unlike looking at the technicals and chart of a particular stock, and noting for example that the 100 day moving average has always provided perfect support for the last two years, or seeing a soaring stock trading 50% higher than the 10 DMA, and looking at the history of the stock and noting that it had rarely or never traded very far above the 20 DMA for any appreciable amount of time, then deciding from that that an imminent correction back to the 20 DMA was very likely. History can often be a guide to the future, as it tends to repeat itself under comparable conditions.
The take-home message here I would say is that excessive call demand is bearish, and excessive put demand is bullish; to the extent that you can get your hands around this demand and quantify it relative to external or internal references, then just to this extent do you have a potentially powerful indicator of market or stock price direction going forward.
Much of this is based on the premise that options speculators are frequently wrong, and when they agree in large numbers, and their position is markedly discordant from the technical, fundamental, or market realities, then they will tend to be much wronger than usual, and so more confidence can be placed in using this information as a contrarian guide. The fundamental reason why this is true relates to who is on the other side of most of these options transactions, and the fact that they have considerable ability to manipulate their markets, have every motivation to get the contracts to expire worthless, and have all the ethics and morals of a shark in bloody waters.
JMVHO, as always.............
Walkingshadow |
