“Someday financial markets will decline...rising stock/bond markets will no longer be government policy. QE will end and money won’t be free. Corporate failure will be permitted. The economy will turn. Someday, somewhere, somehow, investors will lose money and once again come to favor capital preservation over speculation. Someday, interest rates will be higher, bond prices lower, and the prospective return from owning fixed-income instruments will again be commensurate with risk.” Seth Klarman
Wednesday, April 22, 2015
Smart Money: "...readings...have b/c so extreme…they stick out...like Wilt Chamberlain’s 4th grade class picture."
We have mentioned the put/call ratio of open interest on S&P 100 (OEX) options a handful of times over
the past 6 months or so. The reason is that this historically “smart money” indicator has been flashing warning signs off and on during that period. On March 3, we posted our most recent update on the indicator as it was on an unprecedented string of bearish readings. The stock market peaked simultaneously and has drifted sideways in the 6 or 7 weeks since. The bearish OEX put/call readings have not relented, however. In fact, the bearishness has accelerated. Even so, we had not intended to dedicate another post to this indicator so as not to be redundant. However, the readings over the last few days warrant an update as they have become so extreme, they stick out on the chart like a sore thumb – kind of like Wilt Chamberlain’s 4th grade class picture.
As a refresher, we typically scan for extreme readings in put/call ratios in the options market in order to fade them. For example, when a certain put/call ratio reaches what has historically been a high extreme, it is often a “buy signal” in that market as it indicates that traders have become too fearful or bearish due to their preference for puts relative to calls. One market that has historically been an exception to this “contrarian” rule is the OEX options market. For whatever reason, these traders have, more often than not, been correctly positioned at market extremes (i.e., high put/call readings near market tops). And while volume in the market has dropped significantly in the past few decades, its non-contrarian status has not seemed to change.
Since 1998, the put/call ratio on open interest in OEX options has been considered extremely elevated when it has risen above 2.00. From 1998 to 2011, there were just 6 days when the ratio got as high as 2.00. Each of those days either came in the vicinity of a significant market top or at least presented extremely limited upside in the intermediate-term. In the second half of 2014 alone, there were 8 readings. And 2015 has ratcheted up the frequency of such readings to a whole other level. There have now been no less than 34 readings above 2.00, all coming in the past 2 months.
And it hasn’t just been the frequency of the readings, but the magnitude as well. Before a week ago, the highest level of the OEX open interest put/call ratio since 1998 was 2.31 in November 1999. The past 2 days have seen readings of 2.77 and 2.79!