Interesting Chart Utilizing Put to Call Ratios and Volatility

I received quite a few excellent submissions for last week’s chart of the week contest and three subjects seemed to attract the most attention of chartists: put to call ratios; volatility and market breadth.

One chart that did a superb job with put to call ratios and volatility was submitted by Greg Neal. Actually, this was not a single chart, per se, but more of a series of charts which tell a compelling story. Whereas Greg submitted his chart over the weekend, I have used updated data through today and have cut Greg’s chart to two sections to make for easier reading below. In terms of key takeaways, I’ll let the chart and Greg’s annotations speak for themselves.

To find a live version of this chart that is continuously updated at StockCharts.com, click here. The full complement of Greg's public charts at StockCharts.com can be found here.

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

• Yesterday’s Unusually Low ISEE Equity Number
• Chart of the Week: CBOE Equity Put to Call Ratio Nears All-Time Low
• Chart of the Week: Weekly Volume Flow (June 2010 contest winner)
• Chart of the Week: Total Put to Call Ratio (March 2010 contest winner)

[source: StockCharts.com and Greg Neal]

Disclosure(s): none

Chart of the Week: Total Put to Call Ratio

Thanks to all who submitted charts for the chart of the week contest. After getting off to a slow start, I was somewhat skeptical that my idea of opening up the chart of the week to readers would turn out as I had hoped, but when over two dozen submissions landed in my inbox, I was humbled by the breadth and depth of the body of work they represented.

Alas there can only be one gold medal and this time around (I’m sure I will do this again), the winner is Amir from Las Vegas.

Amir’s chart shows how using the CBOE’s total put to call ratio (CPC) could have been helpful in identifying tops and bottoms in the S&P 500 index during the course of the last year. The areas highlighted in yellow show that the total put to call ratio (which summarizes put and call activity for individual equities plus indices) spiking to extreme levels during the June-July 2009 low and just last month dropping to the lowest level in several years. Clearly last month's signal was an excellent time to trade on the short side, at least for the short-term. Whether the extreme reading turns out to be a harbinger of a much steeper downturn remains to be seen.

My personal bias is to use the ISEE and CPCE (equity only) put to call data, but any one of these indicators is capable of generating excellent short-term to long-term market timing signals.

For his efforts, Amir also wins a one year free subscription to Expiring Monthly: The Option Traders Journal.

Thanks again to all those who submitted a very strong group of charts. As much fun as this was, I will be sure to periodically open up the Chart of the Week competition to readers going forward.

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

• Put to Call Ratio and the Probability of a Downturn
• Put to Call Ratios and Volatility Predictions
• Put to Call Data at Extreme Levels
• CBOE Equity Put to Call Ratio Poised to Print Warning

[source: StockCharts]

Disclosure(s): I am one of the founders and owners of Expiring Monthly

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:

• Equity Put to Call Ratio Not Pointing to a Correction
• Put to Call Data at Extreme Levels
• A First Look at the ISEE

[source: StockCharts]

Disclosure: none

Put to Call Ratios and Volatility Predictions

Michael at MarketSci is out with another provocative post this morning. Focusing on the CBOE total put to call ratio (CPC) data history, he uncovers an interesting relationship between an elevated put to call ratio relative to the 50 day moving average and next day volatility in the S&P 500 index. In The Put-to-Call Ratio at Extreme Values, Michael draws the following conclusions:

“High and low put-to-call ratios…have done a pretty good job at predicting next-day volatility… High PCR levels indicate a bearish sentiment (high level of puts relative to calls purchased) and have been followed by a significant increase in volatility (+29.7%). Low PCR levels indicate a bullish sentiment and have been followed by a significant decrease in volatility (-17.3%).”

Looking at over a dozen years of data, MarketSci also concludes that the pattern has persisted over time but has been less pronounced over the course of the last two years (see chart for details).

I will leave the reader to ponder the implications of having a one day edge in predicting SPX volatility, but given how active SPX and SPY options are, there ought to be quite a few different ways to profit from this type of insight.

A First Look at the ISEE

I briefly touched upon the ISEE yesterday; and while the ISE web site has a nice little graph of the ISEE going back a year, it is probably not sufficient to answer even the more casual questions about the usefulness of the index. Fortunately, the ISE has data going back to October 2002 available to download so that you can conduct your own analysis…or you can just keep reading.

For now I’m going to skip over the details of the debate about the usefulness of put to call ratios to help call market turns. If you want to do some research on this indicator, a good place to start would be Bill Rempel’s “The Significance of the Equity Put to Call Ratio” commentary at MarketThoughts.com.

Suffice it to say that I believe that it is worth the effort to watch this contrarian sentiment indicator and suggest that a good place to do so is the SchaeffersResearch.com page that graphs the CBOE equity (non-index) put to call ratio. You can create your own CBOE put to call charts at Stockcharts.com using $CPCE as the equity put to call ticker, $CPCI for the index put to call ticker, and $CPC for the total equity + index data.

The ISEE is actually a call to put ratio based entirely on purchases of calls and puts in which a customer is opening a position through the ISE itself. For more details and a testimonial of sorts I recommend a Wall Street Journal article by Mohammed Hadi.

What do the ISEE data look like? I have graphed the 10, 20 and 100 day SMAs going back to 2002. They show a mean of 154, with obvious extreme readings falling conveniently at round numbers: below 100 and above 200. As a contrarian indicator, a reading of 100 or below is a good cutoff for overly bearish sentiment and a high likelihood of a bullish move ahead; 200 signals extreme bullishness and an increased chance of a bearish turn in the markets in the near future. In many respects, a high ISEE number is a lot like a low VIX number and vice-versa.

Turning to the ISEE as a predictor of future market performance, this is a subject that I will come back to regularly in this space, but for now I have posted a graph of the SPX and the 10 day SMA of the ISEE for the period 10/1/02 to 3/19/07. Note that the four largest spikes in the ISEE all preceded significant moves down in the SPX; also, low ISEE readings frequently marked the beginning of bullish moves.

Before wrapping up this subject for today, I will leave the reader with one last thought: the lowest 10 day SMA ever recorded for the ISEE was an 87.00 last Thursday.