Thursday, April 10, 2008

Relatively High Put/Call A Positive

The market finally broke its consolidation on Wednesday. One intermediate-term positive I’m seeing right now is the action in the CBOE put/call ratio. Today it closed at 1.16. Over the last 4 days it has averaged 1.12. High put/call ratios are normally associated with market selloffs, yet the market made a 20-day high as recently as Monday.

Relatively high levels of put buying are indicative of worry on the part of traders, which is why they are more common during selloffs than during upmoves. I looked back to check other times when the 4-day put/call ratio was above 1.10 and the market was within three days of a 20-day high. Looking back to 1995 I only found three instances: 8/23/06, 2/23/07, and 5/25/07.

August 23, 2006 was a great buying opportunity both short and long-term. It marked a low point and the market rallied for several months following that.

February 23, 2007 was certainly not a buying opportunity. It came just two days before the market collapsed over 3.5% on February 27th.

May 25, 2007 was followed by a 5-day rally and then an extremely choppy month of June.

Not much to learn from these three examples. It should be noted, though that the put/call ratio has been significantly higher over the past couple of years than it was in the beginning of the decade. To adjust for this I normalized the data by using the 100-day moving average.

I once again looked at any time the S&P 500 had made at least a 20-day high in the last 3 days. This time I only required that the four-day average put/call ratio was above its 100-day moving average. After eliminating overlap and looking out at least 20-days I found 47 instances going back to 1995. 33 of these led to positive returns over the next 20 days and 14 of them led to declines – a 70% win rate. The average win was 2.7% and the average loss was 2.5%. The average trade was 1.1%. Not overwhelming numbers by any stretch but not bad, especially considering the market was already at a 20-day high.

In all I would consider the relatively high put/call ratios we are currently seeing a positive. They may help to provide a “wall of worry” for the market to climb.

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