Everybody in the world seemed to be buying put options yesterday.
Okay, that’s a slight exaggeration. Not “everybody in the world” bought puts. But there were enough folks willing to pay up for insurance that the CBOE Put/Call ratio (CPC) spiked up to near its second-highest level of the year.
You may recall that I introduced the CPC to you as a contrary trading indicator earlier this month. Here’s a quick recap…
Put simply, most traders tend to lean bullish. So, most traders buy call options. Therefore, under normal conditions, the CPC will trade below 1.00. That means traders are buying more call options than put options.
When the CPC spikes sharply above 1.00, it means folks are buying more puts than calls. From a contrarian view, that’s potentially bullish.
When the CPC drops sharply below 1.00, it indicates traders are buying more calls than puts – which is bearish from a contrarian standpoint.
Earlier this month, the CPC dropped to 0.77 (the red arrow on the chart below). This told us that traders were getting a bit too optimistic. From a contrarian perspective, it was a caution sign. The S&P 500 was trading near 2750.
Ever since then, the market has had a tough time gaining any ground.
Yesterday, as the S&P 500 was testing the 2700 level as support, it seemed like everybody wanted to buy puts. The CPC closed yesterday at 1.32 (the blue arrow). Take a look…
The last time traders were buying put options this aggressively was back in early April. The S&P 500 was retesting the February lows at about 2580. The index then went on to rally about 120 points over the next three weeks.
Of course, this is just one indicator. And if it was the only indicator showing a pessimistic extreme, then I probably wouldn’t bet too heavily on the outcome. But, we’re also working off of a new Volatility Index (VIX) buy signal. And, the McClellan Oscillators for the Nasdaq and NYSE both reached extremely oversold levels earlier this week.
If we add all of those factors together, it seems to me the market is setting up for a bullish July.
Best regards and good trading,
Jeff Clark
Reader Mailbag
Today, a response to yesterday’s piece on “fishing”…
Hey Jeff and co. I loved the lonely fly fishing metaphor for the gold mining sector. I grew up fly fishing the Upper Sac in my hometown of Dunsmuir! I also have exposure to the sector in my long-term portfolio, so the image is totally appropriate. Now to get the fish biting… Tight lines.
– Steve
And an argument against a rising stock market…
The market acts paralyzed with fear for any type of execution or compromise of trade tariffs. Plus the strength of the U.S. dollar. Earnings will be affected by the dollar. Now above 95… That is a problem.
The Chinese may have to devalue currency again to fight tariffs. That will make the dollar go even higher, let alone the effects on the price of gold and silver. The administration “may” be doing what they think is right for the country, but they are also destroying wealth at the same time in the stock market.
Your call for a healthy good rally in the market starting about now appears very shallow in execution to this point. Of course, one major “tweet” could change that. But sellers are waiting for any strength to blast yet another round, and pound prices.
I get all the technicals. They “should” play out from a huge oversold condition. I hope you are correct. Earnings are also a possible catalyst. Hard trading times now.
– Jeff
Thank you, as always, for your thoughtful letters and insights. Keep sending your stories, questions, and suggestions right here.