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Caution! Option Traders Wildly Bullish at Trader’s Narrative

Caution! Option Traders Wildly Bullish

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While we started to see a trickle of extreme bearish sentiment and some semblance of capitulation in last week’s sentiment overview, yesterday’s option market was shockingly and wildly bullish.

On the ISE, 201 calls were traded (to open) compared to 100 put options (equity only). Including ETF and indices options, that ratio jumps to 220. The CBOE (equity only) put call ratio fell to 0.60, almost confirming the same level of optimism. The last time the ISE sentiment index was above 200 was on the last trading day of 2008, which turned out to be a great contrarian signal:

ISE sentiment march 2009 extreme

But behind yesterday’s wildly optimistic ISE sentiment number, there’s a lot of nuance. So much in fact, that I’m afraid it leaves us with little meaning once we’ve explored it all:

For example, as I mentioned a few months ago, the ISEE index has settled into a narrow range. You can see by the yellow line in the chart above (representing the 10 day moving average) that this has for the most part continued.

You can see that in contrast to what we saw at New Year’s, the 10 day moving average is horizontal. I’m not sure what this narrow range means but it makes me uneasy to see this indicator behave so uncharacteristically to its past.

One possible reason why the options markets have been behaving so crazy is that the common stocks in the financial sector are mercilessly hammered, so the options on them become inexpensive lottery tickets. I’m not sure if there is a way to strip away option trades based on industry or sector so until then, this will remain a theory.

Another potential reason for the rare behavior of the ISE data is that more and more, traders are using leveraged ETFs to take directional bets on the market. These trading vehicles offer almost all the leverage of out-of-the-money options, without having a time value decay.

A final possible explanation is that the ISE is having some data issues. Although rare, I did catch an ISE data reporting error once before. Once again, I’ve looked over my data from them and noticed that somethings just don’t match. So I’ve emailed my contact at the exchange responsible for data integrity and hope to have this question settled at least.

Like all bear markets, it is incredibly difficult to read the cross-currents. Just staying in the game is winning at this point. Stay tuned as I’ll write an update when I clear this up with the guys over at the ISE.

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4 Responses to “Caution! Option Traders Wildly Bullish”  

  1. 1 JJ

    I am new to this but could this be caused my call writing? or just call buyers ?

  2. 2 Babak

    JJ, no, because the ratio is calculated by long calls to open a position divided by long puts to open a position. It is more specific than the CBOE put/call ratio.

  3. 3 david

    It is not so unusual to see ISE options traders stubbornly betting against the direction of the market. In 2006 the ISE Index (measured by the 20day moving average) was constantly moving lower from July to September, while the market was moving higher. The ISE Index did not turn until the market finally jumped above its previous bull market highs made in may 06. I think the rather high ISE Index in the last weeks is an expression of the hope that the market is in the process of forming a bottom.

  4. 4 Russ Abbott

    It could also mean a couple of other things: that the call buyers were (a) looking for a bounce, like today and/or (b) buying calls on inverse ETFs.

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