Follow Up on the Biggest Binge Call Buying of The Past Many Years

I've received several comments and emails from people who do not understand why I call this binge-option buying. What seemed obvious to me doesn't seem to be for many.

The Put/Call ratio (or actually, it's 5 Day Moving Average and 10 Day Moving Average, aka 5DMA and 10DMA) increases when the number of put bought increases relative to the number of call bought and decreases when the number of call bought increases relative to the number of put bought.

Here are the charts of the 5DMA and 10DMA Equity Put/Call ratios which means that they do not include the index options and are usually considered more representative of greed/fear and speculation.

Fear being far more intense than greed, and markets decline faster than markets up legs, generally, the PC Ratio tends to jump quickly and decline in at a more reasonable pace.

As you can see on the two charts below:

  1. The PC Ratio declines sharply, showing a massive number of call options being bought compared to the put options.
  2. The dramatic drop in the PC ratio is even faster than the rise, showing that the reversal from fear to greed has been very fast. A lot faster than any point in time, including the 2008-2009 market crash.
  3. We are now back in the -1SD territory, showing that we are already back to being one standard deviation from the mean of the past three years, showing again a lot of greed and speculation.


Anonymous said...

"1. The PC Ratio declines sharply, showing a massive number of call options being bought compared to the put options."

That's wrong. There are no massive call options being bought at all. Quite to the contrary, what has happened is that there were massive amount of puts bought during early June and now investors aren't buying that many puts anymore, so the MAs have moved back around the mean level.

pej said...

In relative terms, when the PC Ratio declines, it means the number of put bought relative to the number of calls bought is falling. It is the same as to say that the number of calls bought relative to the number of put bought is raising. Note that I'm talking about relative terms

I could actually look at the absolute figures as well. But it won't change the fact that this drop in the PC Ratio is unprecedented, and I am looking forward to seeing the chart for today's action.

Anonymous said...

If you look at that same chart over a 2 year span - put/call ratio has returned to the mean. There is no mania or speculation here, you are just a perma-bear.

pej said...

The 2 year span is actually the span of the biggest S&P rally in history.

So if you believe that this is the "normal" conditions and being at the mean for this period is relevant, be my guest, but don't call me a perma-bear.

On the 3 year timespan, we are now back in the -1SD territory, as I stated in the post.

I'll have to chart myself the 4-5 year ones and find out what they look like.

Tiho said...

Interesting views here...

Anonymous, I follow sentiment quite a lot as well and while I have to agree with pej that this has been of the strongest rallies in the history, lets also not forget that a bear market / crash in 2008 has similarly only happened once before over the last 100 years and that was 1929. These crash events are so rare, that they do not even happen once in a generation.

Therefore, including this rare event into sentiment data does not make any sense either. My personal view as well as the decade long data I follow, says no extreme bullishness at all in the options market.

But than again, so does the chart pej posted, so I don't know why he remains bearish. If you look at the both charts he posted, when PC Ratio gets to 1SD+ means jack shit.

Consider that PC Ratio was 1SD+ in September 2010 and than the S&P 500 rallied over 30%. Even when we go to 2SD+ doesn't mean too much, because excessive bullishness can continue for a prolong period of time during bull markets - because people in bull markets are meant to be BULLISH! That's what investors do, they stay bullish buying stocks and making prices go up. That is a bull market. Simple. Don't fight the trend!

Similarly, excessive bearishness can remain in place during bear markets for much longer than majority expect... because its a BEAR MARKET! Investors are meant to be BEARISH in bear markets. Once again simple stuff. Don't fight the trend!

So many beginners fail to understand this basic, yet such simple rule. Another problem majority of beginners have when they try to be contrarians is that they think every slight bullish sign is a short and every slight bearish sign is a long trade. Read the two paragraphs above and you will understand why that doesn't work.

By the way pej, I do have to agree with the post above that you are constantly perma-bearish. Now there is nothing wrong with that, but famous bearish investors like Marc Faber can even be "contrarians" and stay bullish in a bull market until the top comes.

I read some posts on Babks blog the other day where you shorted Crude Oil with puts at $95 in late February. Crude Oil went higher after that and is still higher than that level today. Even with a big correction in recent times, price still has an upward bias, and bullish sentiment can stay extreme for much longer than normal. And yet so many try to pick tops and short these primary uptrends. If you check that post you will see that I acknowledged that back than and looking at it today, Crude is still near $100 on WTI and above $110 on Brent.

Finally, thank you for the nice msg in regards to my weekly sentiment newsletter. I couldn't find anything decent enough, so I thought I build my own! :=)

pej said...

Thank you guys for your comments. I will reply today or tomorrow at the latest.