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Yesterday, both of the option indexes that I monitor hit a spike high in complacency and greed. The CBOE put call ratio (equity only) fell to 0.43 while the lesser known, ISE Sentiment index (equity only) call put ratio hit 253.
While they both measure option trading activity, there are some differences between them. For starters, the CBOE put call ratio includes large trades while the ISE Sentiment index tracks more retail option traders. Also, the CBOE is a put call ratio while the ISE is a call put ratio. So to be able to compare them better, let’s convert the CBOE put call ratio to the format of the ISE Sentiment index: 294.
So basically, for every 100 put options traded, there was between 253 and 294 call options traded. That’s a lot of greed. Granted, it was just one day. But spikes of such intense emotion deserve our attention. Not only was the spike enough to help the short term moving averages shift dramatically, there is evidence that similar daily spikes presage short term weakness in the market.
I decided to look at all the history of the ISE Sentiment index (equity only) call put ratio and see what has happened in the S&P 500 after a spike of 250 or more, like we saw yesterday. Here are the results:
Including yesterday’s there have been 24 instances (the ISE data goes back to January 2006). Most of them tend to cluster around early 2006, mid-2007 and the fall of 2007. In the short term, the average return for the following 21 trading days (1 month) was -1.08%. Out of the 23 occurrences, 14 were negative and 9 positive.
For all 4 time intervals the returns were negative. But keep in mind that this was a period with a very deep bear market. As well, notice that when we move to the longer end, the 12 month return is negative on average but there is an almost even split between positive and negative returns. That tells me that the result is much less robust.
Needless to say, I’m very cautious going into the rest of the trading week. I think the market has zoomed back to the January highs but at the cost of a very bullish option sentiment. If you’re a contrarian, you just can’t ignore something like this.
I’ll have more about this on Friday, during our usual overview of weekly sentiment data.
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