Tuesday, September 11, 2007

ISEE Buy Signal Coming, But Is It Tradeable?

Updating a previous post, it now looks as if the September ISEE buy signal I was anticipating two weeks ago will arrive as soon as Friday.

I’m sure traders across the globe are bursting with excitement, anxiously counting down the minutes until the ISEE tells them to rush headlong into the markets. But really now, is all this faux buildup worth the effort?

Just in time to answer this question, Michael Stokes at MarketSci.com has looked at the total put to call ratio as a timing tool in a three part series, published today. In short, MarketSci concludes that while the total put to call ratio has some predictable patterns, translating that knowledge into a winning trading system is non-trivial. In the end, they find that the put to call data can be successfully be used to enhance at least one SPX crossover system.

A couple of comments are in order.

First, when it comes to put to call ratios, I have a preference for the ISEE over all the other ratios because they only count opening options purchases. My second choice would be the CBOE’s equity put to call ratio. Third and fourth would be the total put to call ratio (this sums the equity and index put to call data and was used in the MarketSci study) and the index put to call ratio. The theory is that individual investors are more likely to trade options on individual equities, while large institutions will have disproportionate involvement in index options. (Note that the ISEE has recently started breaking out an equities only ratio, but since this data does not go back very far, I do not yet use it.)

Second, put to call ratios are a great tool. So are volatility indicators like the VIX. It always makes sense to look at these two indicators in concert, as I have talked about vis-a-vis the PCVXO and my own version of this indicator, which I have dubbed the PCEVXO.

Third, I recently reviewed an analysis by the CXO Group of the ISEE and CBOE total put to call ratio. You can follow the links in the previous sentence to read their original analysis, but the bottom line is that they were not enthusiastic about either tool, particularly the total put to call ratio.

Fourth, there are a number of books that offer an excellent treatment of put to call ratios; I will only mention three here. Bernie Schaeffer lays out some of his thinking about put to call ratios in Rick Bensignor’s New Thinking in Technical Analysis; Larry Connors and Connor Sen offer an excellent statistical analysis in How Markets Really Work; and Gary Smith explains his thinking and recommends some models of his own in How I Trade for a Living.

So…read, analyze and test. The answers are out there. And have your finger on the buy button Friday, just in case.


Anonymous said...

I thought I read there was a gap on the VIX between 17 and 19.....why can I not see this. Can you post a graph showing this?


Bill Luby said...

FWIW, I don't see a gap on the daily, weekly or monthly charts in this area. With today's action, I believe all outstanding gaps in the VIX (daily/weekly/monthly) have been closed.

Anonymous said...

Thanks, maybe I misread that somewhere else.

Bill Luby said...

There are dozens of VIX charts on this blog to refer to, but FYI you can always check out the generic VIX chart on StockCharts to do your own analysis.

Bill Luby said...

For the record, the ISEE did print a buy signal today, Sept. 17th...but I would wait until the smoke clears after the Fed announcement before implementing any buy program.

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