Trader’s Narrative

Sentiment Surveys
The common sentiment measures like AAII and Investor’s Intelligence haven’t changed significantly from last week so I won’t delve into the details. Most are continuing to show some level of bearishness, which as contrarians we should find comforting.

Consensus’ bullish percent continues to fall faster than a pervert’s pants. It is now at 23% - the lowest since early 2003, when the cyclical bull market began.

LowRisk, being the schizophrenic measure that it is, has now swung completely to the other side. From last week’s 64% bearish to only 36% bearish this week. The bulls are at 46%, easily outnumbering the pessimists.

ROBO Put/Call Ratio
The CBOE equity only put call ratio is the most famous measure of option sentiment but there are a few others. I’ve mentioned the ISEE Index several times (gathered from the ISE options exchange).

I think it is high time I mentioned another. The ROBO ratio is a concoction brewed every week by Jason Geopfert, of SentimenTrader.com

The simplest and most common use of options by unsophisticated traders is to buy a put or buy a call. So Jason takes the detailed raw data from the Options Clearing Corporation, finds the trades for 10 contracts or less to open a position (both puts and calls) and uses them to calculate a ratio. Hence the name: Retail Only, Buy to Open. Simple, and straightforward; but ingenius. That’s Jason for you.

The only disadvantage is that there is a week’s time delay so it is best used in the long to intermediate time frame.

Right now the ratio is at 0.68 - in lieu of a chart: in recent years we’ve seen these levels in July 2004, August 2006, and March 2007.

Meaning that right now, retail option traders are skeptical of the stock market’s ability to recover. As they’ve been since the beginning of the year.

Commitment of Traders
The most recent Commitments of Traders report is showing the commercials (aka, smart money) slightly more net long. at $7 billion (aggregate futures contracts).

That’s a far cry from the unbelievable extremes that they reached last summer in August. Starting in July 2007, as prices declined, the commercials doubled up on their long bets again and again until they reached a brain melting $40 billion net long exposure in August (see chart):

In contrast, the small speculators category (aka, dumb money) decreased their net long exposure to $11 billion net long. In January, they were at an extremely low $6 billion net long (aggregate futures contracts) and are actually still close to their record lows for the past few years.

On the whole, the market underwent a definite extreme position in January. So far it has refused to burst out of that oversold position, preferring instead to meander about, seemingly aimlessly. The danger for the longs is that it could drip lower slowly, not providing any panic short term lows, but instead simply cascading into lower lows and lower highs.

Personally I doubt that because all the indicators that I’m looking at, like those I mentioned above, tell me that we are in a bottoming process. But I could be wrong of course. Maybe there is a piece or two that I’m missing.

With the impending FOMC decision, traders are going to be twitchy and nervous. Although a 25 basis point cut is baked in, until we get confirmation, the market will probably not trend.

If you’ve been reading the blog for the past few weeks, you’re no stranger to my repeated bullish commentary. The market seems to have bottomed right on time with the Nasdaq composite sitting +150 points higher now.

So lets see what the last week brought us in terms of sentiment data:

AAII Sentiment Survey
With the market powering ahead last week with back to back up days, sentiment has shifted. The AAII respondents are neck and neck with 41% bullish and 40% bearish.

Put Call Ratio
The options sentiment ratio spiked up to almost 1.0 in mid November as people rushed to buy puts. But now the equity put call ratio has fallen by almost half. This isn’t automatically a negative as the market has recovered and forced people to back down from their gloom & doom forecasts.

Nasdaq to NYSE Volume Ratio
Although I haven’t said much (or anything really) about this sentiment gauge, it is one of the oldest ones around. The theory is that the two exchanges represent different kinds of equity - Nasdaq was once the platform for unproven, young, and therefore, riskier listings and the big board, the place where all companies wanted to graduate to, the place where the largest, most stable corporations called home.

Of course, over time the difference between the two exchanges has been pretty much eliminated. But this indicator is still going on strong. So by following the ratio of volume on the two exchanges, we can gauge the level at which investors seek risk.

A spike lower in the ratio means that investors are fleeing Nasdaq stocks for NYSE ones and a spike up, the reverse. The most recent market decline in mid November saw this ratio dip to 1.20 - not the lowest it has been, but still very close to the 1.0 level which is the “uncle” point.

More importantly, with the exception of the spike low in November, the ratio has been scraping the ceiling. We’d have to go back more than 6 years to find similarly high readings.

The International Securities Exchange is a relative newcomer to the options market. It offers an all electronic market and has used the leverage of technology to alter the landscape of options trading. The ISE offers one of the most most level playing fields for retail traders. With a growing amount of trading volume the ISE has become an alternative source of options sentiment data.

Most are familiar with the CBOE put/call ratio. But the ISE’s sentiment index is a little bit different. Here’s their own explanation:

“The ISE Sentiment Index (ISEE) is designed to show how investors view stock prices. The ISEE only measures opening long customer transactions on ISE. Transactions made by market makers and firms are not included in ISEE because they are not considered representative of market sentiment due to the often specialized nature of those transactions. Customer transactions, meanwhile, are often thought to best represent market sentiment because customers, which include individual investors, often buy call and put options to express their sentiment toward a particular stock.”

Instead of dividing puts by calls and showing the results as a number, like, say 1.0045, the ISEE shows the number of calls traded for every 100 puts. So when you have a number less than 100, it means that more traders have opened long put options than long call options.

Because the ISEE excludes market makers, and because it only shows opening positions, it presents a fairly accurate measure of sentiment.

During the last intermediate market bottom, there were 3 days where we saw very pessimistic readings on the ISEE. On March 8th 2007, there were 58 calls traded for 100 puts. And on the day before and day after, the ISEE also showed very low readings:

In fact, the reading we saw in March was the lowest in the history of the ISEE (see table below). By contrast, last week, we saw a fairly low reading of 74. But it wasn’t even close to the previous market low. Here are the lowest 20 readings of the ISEE. Also, I’ve included the top 10 daily decreases and increases in daily ISEE readings: