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The markets have definitely provided a challenging environment for trading. With the recent announcement that the Dow officially hit bear territory with a 20% decline from its October high, the gloom and doom in the media is running high. At some point, contrarians will have to decide when the sentiment has turned so negative that it’s time to be bullish.

Optionetics Platinum provides users with a quantitative tool for measuring sentiment which provides alerts for potential reversals, even if it’s only a short-term bounce. When used with other signals, this makes taking action under such conditions slightly more palatable than the strong negative image created when you consider “catching a falling knife”. At this time, actions may include taking profits on short positions, sitting on the sidelines or initiating small long positions.

Sentiment Indicators

When exchange traded funds [ETFs] based on broad market indices began trading with options, index option volume was impacted changing the information gleaned from index put-to-call ratios. Levels that previously marked extremes for the S&P 500 Index (SPX) and S&P 100 Index (OEX) no longer provided a complete picture about the actions of wary market participants.

Add to the mix futures, swaps and inverse mutual funds and ETFs (funds based on the short performance of a broad based index), and more dampening occurs for the traditional index put-to-call ratio. It makes it difficult to look to one option measure to gauge sentiment. It doesn’t mean however that you can’t make use of this sentiment tool. Consider evaluating security performance post extreme levels when using put-to-call ratios.

Put-to-Call Ratios in Platinum

Since technology often leads the broader market, here we’ll take a look at short-term implications for QQQQ which is the (Nasdaq-100 ETF.  Figure 1 provides a two year chart pulled mid-day on 7/2/08 for the put-to-call ratio and price chart for QQQQ. Each chart includes a 20-day simple moving average [SMA] with the 50-day SMA also on the price chart.

The price chart includes red lines drawn from spikes in the put-to-call ratio that are larger than, or approximate, the current ratio spike (11 cases). The ratio spikes do not correspond with price lows; however, in 9 of 11 cases QQQQ moved higher in the short-term. The other two cases coincided with short-term price peaks. It’s not impossible for Tuesday’s modest movement upward to represent a third price peak, but given the two-year history, it’s more likely prices will move upward in the short-term.

Figure 1: Two Year QQQQ Put-to-Call Ratio and Price Chart with Ratio Spikes Highlighted

If you pull up the QQQQ put-to-call ratio chart for 7/2/08, you can see that the ratio ended the day at a level of 2.59 versus 3.37 which appears at mid-day (Figure 1). Since put volume is not being subtracted during the day and there was no short-covering rally towards the close, the volume seems to suggest short positions are being hedged ahead of the official employment report on 7/3/08 when this article appears.

Figure 2 provides the end of day volume in an eight month Put-Call Volume chart from Platinum.

Figure 2: Eight Month QQQQ Put-Call Volume Chart

The information, which is largely trader oriented, seems to imply continued weakness is expected in the very short-term (days). A second put-to-call ratio spike may be needed to reverse the trend (note the instances of upward spikes that appear close together).  In the event the employment data released Thursday is stronger than the consensus, a short covering rally may occur in the early portion of Thursday’s abbreviated session.

Whenever a more cursory explanation of stock market moves occurs these days it usually includes a comment about the oil markets. From an intermarket analysis perspective, the US dollar [USD] leads commodities moves and is something a trader should consider when evaluating the big picture. Since the US Dollar Index is based on the relationship of the USD to seven major currencies, including the Euro, Thursday’s Central Bank meeting and interest rate decision from the European Union matters. Indications for a hike have already been built into the USD, but strong statements regarding continued hikes could hurt the dollar and the US stock market in the short-term.

To access other articles written by Clare White, please click here.

Clare White
Contributing Writer and Options Strategist
Optionetics.com ~ Your Options Education Site
Questions for Clare? Visit the Optionetics.com Discussion Board

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