The last time that we saw retail option traders, as measured by the ISE Sentiment index, being this bullish was a few months ago, in mid April 2010: Today it is the Retail Option Trader’s Turn to go Crazy. That was the crescendo to the binge buying of calls earlier in April: Option Traders Go on Call Buying Binge.
While I tracked and pointed this out as it was happeneing, I’m guilty of not being bearish enough in that instance. With hindsight, the April high was an intermediate term top for the S&P 500 index.
Today, as the market once again revisits the 1220 level, retail option traders are approaching the same level of enthusiasm as what we saw in April and based on another measure, have even surpassed it.
Here is the chart showing the daily ISE (equity only) call put ratio (dashed black lines) as well as the 10 day moving average of the ratio:
Perhaps even more interesting is that compared to the very recent and latest attempt to take out this resistance level, option traders are wildly more bullish now than they were about a month ago.
Consider that the S&P 500 index made a high of 1227 on November 5th 2010. A few days later (on November 15th) the 10 day moving average peaked at 216. The lag is an inherent nature of a moving average indicator of course. The 216 number meant that retail option traders were buying 216 calls for every 100 puts to open a trade.
Meanwhile, today as the S&P 500 index is once again approaching that level (today it hit a high of almost 1226) the 10 day moving average of the ISEE sentiment index is 231.6. So now, even though arguably the S&P 500 index is a tiny bit lower, there is significantly more call buying.
One easy way to reduce the lag in the call put moving average indicator above is to cut it in half. The shorter time frame is a snapshot of a rolling 5 day trading week. If we look at the 5 day moving average of the ISEE sentiment index, we see that it is now at an all time high:
This indicator has a relatively limited time range since it started in January 2006. But even so, the current 5 day moving average of the ISE (equity only) call put ratio stands at 268.
That means that retail option traders are buying 268 calls for every 100 puts (to open a trade). Compare this current level of buying frenzy to what we saw just a month ago when the S&P 500 was at similar levels. On November 8th, the 5 day moving average ISEE ratio peaked at 231.
While the market may have the wind at its back due to positive seasonality, with sentiment data like this from the option pits, I wonder just how much of that expectation is already baked in the market.
To the left, you can see the 10 day moving average ratio ranked in descending order from instances of 225 and higher.
It shows that the present bullish condition is very rare. Retail option traders have only spent 1.87% of the time buying this much, or more, calls. That is to say the ISEE Sentiment index has only been above 230 for 23 days out of a total of 1232 days for which we have data. So the present situation can rightfully be called extreme. If we extend it to 225 or more, we’ve only see the ratio above this threshold 2.68% of the days.
Put another way, more than 97% of the time, we see less bullishness from retail option traders than we are seeing now.
As well, the top bullish spots are claimed by just a few time intervals. I’ve color coded them so that they are easier to spot:
- January 2006
- July 2007
- October 2007
- April 2010
- December 2010
Those dates should be all too familiar to you. In all previous instances, except for January 2006, the equity market corrected as a result. The case of January 2006 is an exception, however it was a Pyrrhic victory for the bulls because while the market didn’t fall significantly, it didn’t really go anywhere for the next 8 months. It was only by September 2006 that the S&P 500 shook off the doldrums and pushed higher right through to the end of the year.
It remains to bee seen how the equity market will behave following this same pattern of bullishness on the part of retail option traders. Based on historical precedent and on other sentiment indicators, the bulls might want to watch where they tread.