40 lines
3.1 KiB
Plaintext
40 lines
3.1 KiB
Plaintext
S22 Part V: Index Options and Futures
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Interpreting the Ratio. There are several philosophies as to how to inter
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pret the ratio once it has been calculated. All philosophies are of the contrarian
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variety, so the general comments made earlier that high ratios are bullish and
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low ratios are bearish still hold true. However, quantifying just what is "high"
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and what is "low" leaves room for interpretation.
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One school believes that absolute ratios should be used. An example might be:
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"if the 10-day moving average of the equity put-call ratio is over 0.60, that is a buy
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signal." Unfortunately, applying absolute figures to any of the ratios can be counter
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productive at times. If the market is in the grip of a prolonged bearish move, more
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and more puts will continue to be purchased, sending the ratio quite high before it
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can reverse and start coming back to normal levels. Therefore, it is better to look for
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the ratios to make a high or a low before calling a buy or sell signal. This is a more
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dynamic interpretation; it allows for buy and sell signals to come at different absolute
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levels of the put-call ratio.
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Figure 29-1 shows the 50-day equity put-call ratio going back several years (the
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daily figures for the previous 50 trading days are averaged to produce the number
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plotted on the chart each day). One can see that at certain times, the put-call ratio
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reached extreme heights before finally generating a buy signal. Attempting to call a
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buy on the market at an absolute level would have been an error because the entry
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point would have come too early. Notice that the readings in late 1990- as the mar
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ket bottomed in advance of Operation Desert Storm - were actually higher on an
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absolute basis than those made after the stock market crash in 1987. Similar obser
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vations can be made for sell signals after the ratio has reached low levels: don't antic
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ipate - wait for the ratio to bottom out and tum up before declaring a sell signal or
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to roll over and turn down before declaring a buy signal.
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The index put-call ratio is shown in Figure 29-2. It tells a similar story to the
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equity ratio, although there are certainly differences - beyond the obvious one that
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the ratios have different absolute values. Note that this ratio averages about 1.00
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while the equity ratio averaged about 0.50.
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At times, index put buying becomes extensive even as the market climbs. This
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does not generally happen with equity options. It seems that institutional money
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managers, who are long stocks, are afraid that they will lose their profits after a quick
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stock market advance. However, rather than sell their stocks, they buy puts (possibly
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overpaying for them). Thus, they are really bullish (they own stocks), but they are
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buying puts as a hedge.
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This is a difficult situation for the contrarian. What is the institutional manag
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er's true bias? Is he bullish because he still owns stocks or is he bearish because he
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is buying puts? This is the bane of contrary analysis - attempting to accurately inter
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pret the data that is being received. Figure 29-2 shows that the index put-call ratio |