Market Timing & The Put/Call Ratio

[wayneL]

FWIW

The chart below shows the 20 day average of the total put/call index, Generally, when this average extends below 1 standard deviation there is some sort of a market top; an intermediate top at least. We are now at 2 standard deviations.

 

[mazzatelli1000]

Sorry about that
I shouldn't have been trading all those calls

 

[skyQuake]

FWIW

The chart below shows the 20 day average of the total put/call index, Generally, when this average extends below 1 standard deviation there is some sort of a market top; an intermediate top at least. We are now at 2 standard deviations.

Hey wayneL, is that a rolling StDev ?

 

[el caballo]

Hi Wayne,

Thanks very much for the chart. Can I ask how the two lines are computed and interpreted, and the source of the chart?

Thanks,
Greg

 

[wayneL]

@skyQuake

Yes, in the sense that it is computed on the data series contained in the chart, so the next day's 1 year chart will drop the oldest day from the previous chart. If you were plotting it on your charting software, it would be the lastvalue() of the 252 moving average.

@the horse

The black line is a line graph of the S&P500

The red line is the 20 day moving average of the put/call ratio. The put call ratio is the daily number of put options traded divided by the number of call options traded, and is used as a contrarian indicator, much like VIX.

 

[chops_a_must]

Yes... and you should go long at 40 on the VIX...

 

[wayneL]

Yes... and you should go long at 40 on the VIX...

Haha yes.

But that was always bubblevision's line... actually it was something like 37-38% IIRC.

As with all leading indicators, don't check your brains at the gate... and don't use in isolation.

 

[chops_a_must]

The way I see it.

Nothing like this has been experienced since the 30s. So unless you've got data for then, it's pointless.

You got any figures on temporary bottoms for that, and what it looked like in November?

 

[wayneL]

The way I see it.

Nothing like this has been experienced since the 30s. So unless you've got data for then, it's pointless.

You got any figures on temporary bottoms for that, and what it looked like in November?

Well, The market "thinks" things are returning to normal, we see that with VIX dumpage.

VIX at 35% or whatever it is at the moment may seem high, but when compared to relaized volatility, it is actually lower. This is not a fearful market. It's a market with elevated volatility, when compared to the zombie bull run of 2003-2007, but not a market concerned with downside.

P/C ratio also shows that. On a contrarian basis, we should be watchful for at least a retracement.

 

[wayneL]

Thou shalt not ignore the put/call ratio

 

[BentRod]

Right on time

 

[Sean K]

Thou shalt not ignore the put/call ratio

Just one bad day.

Tomorrow a million more jobs will be lost and the market will jump 3%

 

[Logique]

WayneL,
thanks for that chart. The 20 day MA of the Put/Call ratio does seem to co-incide inversely with the S&P500 peaks/troughs, so the fear must be of a further slump in the S&P500.

However on the positive side, it might appear that the ratio of Puts to Calls is in a downtrend channel, thus less market fears of downside as you said. Particularly if the view is taken that Puts are mostly bought, and Calls mostly sold, both often going un-exercised - btw am I right to make this assumption?

 

[sinner]

Generally, when this average extends below 1 standard deviation there is some sort of a market top; an intermediate top at least. We are now at 2 standard deviations.

Asusming the inverse is true, if you had gone long the SP500 when the put/call 20MA had hit 2SD on the upside in October, you would still be at a loss today despite the 20MA having moved "4SD" in the meantime.

 

[wayneL]

Asusming the inverse is true, if you had gone long the SP500 when the put/call 20MA had hit 2SD on the upside in October, you would still be at a loss today despite the 20MA having moved "4SD" in the meantime.

That's true, and no leading indicator is 100% accurate. What you are doing with leading indicators such as put/call, VIX et al is to build up a hypothesis to enter a market position.

As ever, price trumps all. It would be a brave (wo)man who went all out long on the strength of put/call in those circumstances of a crashing market. There was a bit of a dead cat bounce however, and the downward momentum did slow from that point. So we can claim some small success from that signal.

A sensible stop loss/money management is always prudent when your hypothesis turns out to be wrong as well.

 

[sinner]

That's true, and no leading indicator is 100% accurate. What you are doing with leading indicators such as put/call, VIX et al is to build up a hypothesis to enter a market position.

As ever, price trumps all. It would be a brave (wo)man who went all out long on the strength of put/call in those circumstances of a crashing market. There was a bit of a dead cat bounce however, and the downward momentum did slow from that point. So we can claim some small success from that signal.

A sensible stop loss/money management is always prudent when your hypothesis turns out to be wrong as well.

Hi wayneL,

You can safely ignore me, I am just playing a bit of devils avocado trying to stir the pot

Really I do appreciate the sort of info you provided! Just to drive your point home, if (wo)man had gone short at -2SD, she would be a happy camper today, >100 points on the SP500 lost since then, and not just over 1 day!

Here is an updated chart.

 

[wayneL]

Hi wayneL,

You can safely ignore me, I am just playing a bit of devils avocado trying to stir the pot

Really I do appreciate the sort of info you provided! Just to drive your point home, if (wo)man had gone short at -2SD, she would be a happy camper today, >100 points on the SP500 lost since then, and not just over 1 day!

Here is an updated chart.

Nothing wrong with devil's avocados.

I've been known to play that part myself. :batman:

Avocados with chilli... good eating too.

 

[BentRod]

Here is an updated chart.

Yep good stuff eh.

@Wayne....Thanks for putting us onto this one mate

Below is MuppetDX (not SPX) :

 

[sinner]

Hi guys,

I have been following this pretty closely since wayneL was nice enough to illuminate this excellent contrarian indicator for us with less experience.

An updated chart is included below. I tried the 3 year DJIA chart to "normalise" the results somewhat. As you can see from the last few years of price action, the put/call 20MA portrayed a market bearishness that was not indicated in the price movement.

While the 20MA rarely ventured below -1SD in this chart, sellers pushed the same 20MA way up (and above) +2SD on the upside as the price reached all time highs. Obviously the put/call ratio was trying to tell us something at the time, for anyone willing to listen.

Anyway, fast forward to the present day. I have included some lines to make the picture even muddier.

Also, wayneL I was going back across some of my older posts looking for a chart and discovered a post by you along the lines of wishing to see a long term SP500 chart I posted, as an inflation adjusted chart. I must have missed reading it earlier. So as a thankyou present, I tried to find one, but the best I could come up with was this inflation adjusted DJIA chart. Hope it's exactly what you wanted!

http://home.earthlink.net/~intelligentbear/dj-lt-infl.gif

Linked from http://home.earthlink.net/~intelligentbear/com-dj-infl.htm "Fred's Intelligent Bear Site". Worth a check out, as he also had an adjusted chart comparing this crash to 1964-1984 period as well as explanatory commentary for the above chart. Very interesting.

 

[sinner]

Hi guys,

This indicator has been spot on the last two times it hit -2SD and you could have made a crap-load of money if you went long the VIX short SP500 each time this happened.

This time we have already travelled below -2SD and hooked up without any sign of a decline.

So is the market about to rally hugely despite being overbought (just like it slumped hugely despite being oversold), or is the put/call 20MA portending the mother of all market slumps?

Would appreciate your input.