Let’s Add This Indicator to the Caution Pile

This surprised me Wednesday…

This is the CBOE Put/Call ratio. It shows the volume of puts traded divided by the volume of calls.

The ratio usually hangs out near 0.90 – 0.95, because there are almost always more calls traded on any given day than puts.

When it gets above 1.20 it means traders are jumping over themselves to buy puts. That often happens near the end of a decline phase, and it’s a good signal we’re near at least a short-term bottom for the broad stock market.

When the ratio falls below 0.80, traders are excitedly buying calls – which usually happens near at least a short-term top. Indeed, the few times this ratio dipped below 0.80 in May, the S&P 500 pulled back almost immediately.

It doesn’t surprise me the ratio is below 0.80 now… After all, I’ve been arguing that folks seem a bit too enthusiastic about the market. It surprises me that this happened on Wednesday.

You might recall, on Wednesday the stock market opened higher. In fact, the S&P 500 traded as high as 6059. That’s the highest we’ve been since the market peaked in mid-February. But, on Wednesday, the bulls couldn’t hold the gain. Stocks reversed midday, and the S&P closed at 6022 – down 16 points for the session.

That action – opening higher and then closing lower – is generally bearish. It should have prompted some put buying, or at least cooled the heels of call buyers.

Instead… traders were enthusiastically buying calls, as the market was falling.

That’s a signal that investor sentiment – a contrary indicator – is too bullish.

So, let’s throw this on the ever-growing pile of indicators screaming “CAUTION!”

That’s why, earlier this week I did a broadcast about what strategy I deploy in these kinds of markets – that have led my subscribers to 19 winning trades out of 23 in my newsletters since April 2.

You can access that talk until Monday, June 16 right here.   

Because there’s a lot more risk in this market than most folks care to admit. Chasing stocks higher into overbought conditions is rarely a good short-term move.

Traders who are looking to put more money to work will likely have a better opportunity to do so in the days and weeks ahead.

Best regards and good trading,

Jeff Clark
Editor, Market Minute