In last week’s sentiment overview I mentioned that the options market was showing a major shift towards puts, which from a contrarian perspective is bullish for the market. With today’s decline, that move has accelerated. So much so in fact that we are now, arguably, seeing the most fearful market since the bear market bottom that launched the cyclical bull market we’ve enjoyed for the past few years.
The CBOE equity only put call ratio hit a high of 1.11 today – the highest since November 19th 2008 when it reached 1.16. That pushed the already fast climbing 10 day moving average to 0.83 – the highest since late January 2009:
The CBOE put call volume data can vary significantly over time. During particular periods, what was once considered a ‘ceiling’ gets shattered and a new range is set. And at other times, the put call ratio seems to sink lower and lower, breaking all previous definitions of a ‘floor’. We can normalize the ata to avoid any confusing that this straying effect could cause over time. Credit for this idea goes to Jason Goepfert who has a great service at SentimenTrader. It is a similar idea to the normalized breadth indicator I mention here.
The idea here is simple, we take a short term moving average and we use a long term moving average to orient it so that it self-corrects. I chose the short term moving average I usually use (10 days) since it represents two trading week’s worth of activity. For the long-term moving average I used 125 days since that is about half a year’s worth of trading days. Of course, you can play around with different moving averages but it should give you almost the same picture as below:
The normalized CBOE put call ratio does a good job of finding important inflection points (but it missed the March 2009 low). And the current reading confirms that what we are seeing is truly extreme.
Regular readers will remember the OEX put call volume ratio as well as the OEX open interest put call ratio that I’ve mentioned multiple times since February. This ‘smart money’ indicator had been flashing a warning sign for months and with hindsight we can see its effectiveness once more as the S&P 500 index has been basically flat in that time period.
The ISE put call ratio also showed a large shift towards put options today. But the move on that option exchange was not as pronounced, reaching only 0.87 (or 115 expressed as a call put ratio). The 10 day moving average likewise is not as extreme as the CBOE market. But the retail crowd is by far preferring put options which is a strong contrarian signal.
Sentiment surveys meanwhile show a continuing decline in optimism. The Investors Intelligence survey of newsletters has been the most stubbornly bullish among these in recent times. The bears this week increased to 26% (from a recent low of 15.7% in April) and the bulls declined to 37% (from a recent high of 57% in April). The usual suspect of sentiment indicators will arrive with the rest of the week and as always, they will be in the weekly sentiment overview on Friday.
tradersnarrative 
Hi Babak,
Will it be a coincidence if we bottom next week with the FOMC meeting? I ran my model and came up with an interesting observation
Excellent analysis. From your normalized chart, we can see that a similar normalized put/call level was reached in March 2008 – a full year, and 50% above, the 2009 bottom. In isolation, this indicates to me that we could still have a long way to fall… But interestingly you mention that from a contrarian perspective this level could be considered bullish. In my experience, being contrarian has typically lead me to be disasterously early on a move – could this be another case in point? Time will tell.
Wow 2 days now of CBOE Equity >1 and OCC equity put volume >10MM