Wednesday, May 7, 2008

Equity Put/Call Ratio Spikes Down

Dr. Brett Steenbarger over at Traderfeed has done some excellent work with put/call ratios over the last few years. One way he measures it is by comparing a short-term moving average of put/call volume to a long-term put/call moving average. He has demonstrated numerous times how spikes in the short-term averages over the long-term averages tend occur near market bottoms.

The options market is now experiencing a spike down, rather than a spike up, in the put/call ratio. An example of this could be seen by considering the 5 and 65 day moving averages of the CBOE Equity put/call ratio (two averages that Dr. Steenbarger sometimes uses). As of tonight’s close the 5-day stood at 0.62 and the 65-day at 0.80. This is over a 20% gap from the 65 to the 5.

If spikes up in the put/call can predict a bottom, could a spike down predict a top?

Not based on the limited data available. The equity put/call data has only been tracked back to 2003. Below are the results:

The dates for the 4 instances were 11/10/04, 12/16/04, 5/24/05, and 7/14/05. Basically it happened at times where the market rallied strongly following a pullback or correction. I suspect the sharp drop in the average put/call ratio represents a shift in attitude of market participants. Coming out of a corrective period it appears this buying enthusiasm is a good thing and not representative of complacency.

I also ran the same test using the Total Volume Put/Call Ratio back to 1996. Results there leaned to the bullish side as well with between 57% and 67% of cases showing continued gains over the next 2-3 weeks.

The low put/call ratios may become an issue if they remain low for an extended period. I’d be careful of trying to call a top based on any spikes lower in the ratio, though. Spikes may represent enthusiasm rather than complacency. Now if we could just get some volume we could really make a case for enthusiasm.


Anonymous said...

I have been tracking the 10 and 21 day CBOE and Equit P/C for sometime. It is a relative "indicator" i believe and it can indeed help predict a market intermediate top or bottom. When these approach an above average high (like VIX, there is no absolute number to gauge this by, so you have to base it on historic highs over the last several years i believe), the market is on strong footing. Only recently i had pointed out to colleagues that this ratio hit a significant high and was reason to hold steady while everyone harped on the economy, oil, currency etc. However, they have now retraced significantly, BUT at levels that are NEUTRAL. The percentage retrace in a given period is not important i found, but rather the relative low is. It looks to me that when the Equity P/C avg drops below .60, it will be time to become very defensive and we should either be in mostly cash or shorts.
As the P/C average drops, it indicates insitutions opening out right shorts on the market and heging with calls; conversely when the averages climb, there is reason to be optimistic as it indicates insitutions or those in the know going long and hedging with puts.
As of right now, i do tend to think this market will continue to retrace for a little to shake out longs and draw in bears before closing the trap.


indextrading said...

What's the symbol in TS for CBOE equity put/call ratio? I tried $wpcve But it looks like the data is noisy.

Rob Hanna said...

Thanks for sharing your thoughts MBS.


Tradestation's put/call symbols are a mess. I download the data directly from the cboe website and then import it as a 3rd party symbol into tradestation. Below is the CBOE address:

- Rob