Wednesday, February 13, 2013

Put-Call Moves Opposite To Indices

One of the "sentiment" measures in the Weekly Market Summary is the trend in the put-call ratios (CPC - total; CPCE - equity only; CPCI - index). Lawrence McMillan of the Option Strategist makes an interpretation each Friday. Read his weekly commentary here.

He uses a 21 period MA. You can also look for a pattern of highs and lows. To wit, when CPC is falling (less put protection, fear receding), $SPX typically rises. See the first chart:

Conversely, when CPC rising (puts in demand), $SPX typically stalls and eventually falters. As usual, tops are more difficult and you see long divergences where indices are flattish while put-call rises. Someone always knows something.

The basic point, as always, is to look for headwinds or tailwinds. An extended uptrend after which put-call is low and starting to rise is a headwind you should be aware of.

Importantly, you can also identify capitulation points where CPC hits an extreme high or low. This is part of the Fat Pitch arsenal signaling a possible change in trend. CPC over 1.3 represents panic; under 0.65 is Humbolt County complacency. This will be the subject of a future post.

I've simplified the trend analysis to make a general point. Real time, determining the trend is hard. McMillan has recently been expecting CPC to rise (caution) but this week he is less certain. You'll see plenty of undulation within any trend. Nothing is easy.