Thursday, December 10, 2009

Put to Call Ratio and the Probability of a Downturn

In the last day or two I have been fielded several questions about put to call ratios. It seems as if some investors are concerned that there is a stealth movement by sophisticated investors who are making substantial bets on a downward move with large purchases of puts. Invariably, these concerns have led to questions about what I see in the put to call ratios that will confirm or deny this.

To quickly recap, the CBOE publishes three put to call ratios. In my preferred charting site, StockCharts.com, these are known as:

  • $CPCE – the ticker for the equity put to call ratio
  • $CPCI – the ticker for the index put to call ticker
  • $CPC – the ticker for the total equity + index data

For reasons I have discussed in the past, I prefer the CPCE ratio and use this as a contrarian signal. The problem with the CPCI data is that institutional order flow for index options tends to come in large chunks that can create misleading short-term signals.

Recently, however, the CPCE, CPCI and CPC have all had very similar looking charts. I have reproduced the six month chart of CPCE below and it shows no unusual spikes in put activity relative to call activity. If anything, the 10 day EMA that I use to smooth the sometimes noisy CPCE data shows an almost eerie flat line for the past month or so, just as was the case when I last wrote about put to call ratios when in Equity Put to Call Ratio Not Pointing to a Correction when the Dubai debt crisis hit.

For more on related subjects, readers are encouraged to check out:

[source: StockCharts]

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