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Option traders are down right giddy with optimism. Of course, this is nothing new. Last month it was the ISE sentiment which showed retail option trader reaching for gains, completely oblivious to risk.
Coming into this month, they have continued to press their luck with an astonishing amount of persistence. The call buying binge isn’t even restricted to the retail option traders. As I wrote last week, institutional option traders are dedicating a huge amount of their total option positions to calls.
While the ISE data was extreme enough for us to take notice, the recent CBOE data is actually off the charts. Since I prefer to look at the equity only put call option ratio, we have to contend with a much shorter history for this data series (as opposed to the total put call ratio).
Today the CBOE equity only put call ratio was 0.32 - implying more than 3 times as many call options were traded for every 1 put option. That is the lowest daily reading in this series since the data was collected in late 2003.
A new daily low is definitely worthy of our attention, but what is truly astonishing is that the 10 day (or 2 trading week) average is also at an all time low: 0.454. This means that on average in the past 2 trading weeks, traders at the CBOE have bought 220 call options for every 100 put options:
To find the next closest level of daily bullishness, we have to look back to January 16th 2004 when the ratio was 0.35 (or 285 calls for every 100 puts). By coincidence, that is also the next lowest reading for the 10 day moving average: 0.483 (or 207 calls for every 100 puts).
While this may paint an extremely gloomy picture for the equity market going forward, the short history of CBOE option sentiment is actually not all that bleak. We’ve only had a few similar periods of time when the 10 day moving average has fallen to comparable levels. These were:
- January 2004
- November 2004
- July 2005
- January 2006
- October 2009
Most of the time, it resulted in moribund returns with the S&P 500 trading sideways to work off the excess bullishness. You can argue that the gains that followed October 2009 were given back quickly - returning the S&P 500 back to the 1075 level. It may be surprising that the market can maintain itself so well in the face of extreme optimism. But keep in mind that we are working with a small sample size. As well, all of them occur within cyclical bull markets, like the one we are in now.
This confirms the previous study of the ISE sentiment index extremes that shows the S&P 500 with a small negative return over the few months. But nothing like a break that results in major losses. This conclusion in turn, confirms the healthy and continuing cyclical bull hypothesis outlined by both Ned Davis Research and Lowry Research.
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