One of my favorite trading indicators has come back to life.
The CBOE Put/Call (CPC) ratio measures investor sentiment. It takes the total volume of put options traded on a given day and divides it by the total number of call options.
Whenever the ratio spikes above 1.20, it indicates traders are rushing to buy put options and make bearish bets. That’s bullish from a contrarian standpoint.
When the ratio drops below 0.80, traders are aggressively buying call options and betting on an upside move. That’s ultimately bearish.
The CPC used to be a highly reliable indicator. We mentioned it often here in Market Minute. And it had an excellent track record – until about one year ago.
That’s when 0DTE (zero days to expiration) option trading became popular.
Traders started gambling on the intraday direction of the stock market. They bought short-dated puts and calls that expired on the same day they bought them.
That action wasn’t indicative of traders’ bullish or bearish sentiment of the market. Rather, it was a gamble on where traders thought the major stock market indexes would finish the day.
That activity skewed the option volumes, rendering the CPC all but useless.
Now, though, the market has absorbed the allure of intraday gambling. And the CPC is starting to trigger reliable signals again.
For example, in early August – after the S&P 500 had fallen 9%, and it looked like the world was ending – the CPC hit 1.28. That coincided with a bottom in the stock market.
In late August, after the S&P 500 had rallied all the way back to 5650, the CPC hit 0.74. The S&P 500 dropped 250 points just a few days later.
So, it’s probably worth noting the CPC hit 0.76 last Wednesday. It was 0.79 on Thursday.
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Traders were jumping over themselves to buy call options last week. That sent the CPC below the 0.80 level that indicates high bullish sentiment.
This condition often leads to at least a short-term decline in the broad stock market.
And given the other warning signs I wrote about last week, the CPC might be indicating an intermediate-term correction is headed our way.
We’ll see how this plays out in the days ahead. But given the previous success of the CPC indicator, I wouldn’t bet against it.
Best regards and good trading,
Jeff Clark
Editor, Market Minute