"ISEE Equity Call to Put Ratio at Highest Level in 16 Weeks
The ISEE equity call to put ratio hit a 16 week high of 189 on Friday, as investors showed a strong preference for calls over puts. Today that ratio is even higher, at 215 as of 11:30 a.m. ET.
Trading is light so far and extreme values in the ISEE have a tendency to revert to the mean (146) as the day wears on, but coming on the heels of Friday’s high number, I believe the ISEE numbers should bear watching throughout the day.
For the record, the last time the ISEE equity call to put ratio was over 200 in a single session was back in the middle of May. At that time, the markets were just in the process of putting in a post-March top.
[source: International Securities Exchange]
The Put/Call ratio is a popular sentiment indicator. These types of indicators attempt to gauge the prevailing level of bullishness or bearishness in the market. Typically, sentiment indicators are used as contrarian tools. In other words, when market participants are most bullish, the likelihood of a downside reversal is greatest. And when investors become overly bearish, a market rally may be on the horizon.
How It Works:
There are several Put/Call ratios in use. The one that many investors rely on is based on data collected by the Chicago Board Options Exchange (CBOE). Each day, the CBOE adds together all of the call and put options that are traded on all individual equities, as well as indices like the OEX, or S&P 100. Purchasing a call option, you'll remember, simply amounts to a bet that a particular a stock or index will rise in value. By contrast, a put buyer is anticipating that an underlying stock or index is poised to fall.
Each day the CBOE calculates the ratio below:
Volume of put option contracts / Volume of call option contracts
On days when the major averages perform strongly, the number of calls bought typically far outweighs the number of puts. On these days, greed prevails and the put/call ratio may be very low -- perhaps in the neighborhood of 0.70. On days of deep market weakness, however, fear prevails and the number of puts purchased is generally far greater than calls -- possibly reaching 1.10. While 1.0 might seem to be a neutral reading, there are more calls than puts bought on an "average" day. As such, a reading of around 0.80 is about "normal" on this indicator.
The daily put/call line, when plotted on a graph, is very erratic. To make the graph easier to read, most charting packages allow you to plot a moving average to smooth out the raw data. Common moving average periods are 10 and 21 days.
Why It Matters:
The put/call ratio works well in conjunction with overbought/oversold indicators such as the Arms Index and McClellan Oscillator. When you begin to see consistently extreme readings across several different measures, it is a good sign that a market reversal may be on the horizon. Traders should recognize these signals and incorporate them into their trading tool kit. Using the Put/Call ratio as a contrary tool can help you avoid getting swept up in the prevailing sentiment, which often leads to buying when the market is high and selling when it is low."
The International Securities Exchange (ISE), which publishes a superb implied volatility chart that I have featured on VIX and More on a number of occasions, has recently launched an enhanced version of their IV chart. The new version of this chart, which I have appended below, adds an “ISEE value” to the list of data. I have discussed the ISEE call to put ratio frequently in this space in the past. In this incarnation it is simply a ratio of call volume to put volume for the specified security."
From Trading Markets:
"Technicians have long used put/call ratios as a method of assessing market sentiment. Conventional wisdom issues a contrarian signal when an apparent imbalance occurs between the trading volume of calls versus puts.
The logic from the wise-guy camp states that excessive volume in either calls or puts highlights extreme levels of bullish or bearish conviction. Excessive bullishness often foreshadows an overbought market condition. If too few buyers are left on the sidelines then long liquidation or short selling will force the market to auction lower without usual levels of support.
Traditionally the most popular put/call ratio was derived from volume on the Chicago Board of Options Exchange (CBOE). The CBOE p/c's are listed on their web site with the ratios recalculated throughout the session. Several years of daily put/call data is readily available at www.cboe.com. The formula for the classical put/call ratio is simply volume of calls divided by volume of puts. The higher the value of the ratio the larger the number of traded puts versus traded calls.
Because calls are typically traded by investors in larger numbers than puts, a normal p/c ratio in equities would be around .70 or lower. Due to portfolio insurance, index traders tend to favor puts to a greater degree than calls. A p/c ratio among index products is usually around 1.4 or better. Combining the volume of stock options together with index options creates an all product p/c with a benchmark of 1.0 an accepted norm.
The importance of Options Traders' personalities
The simplistic math deriving the vintage put/call ratio tells us too little about the character of options participants.
For starters a single trade of massive proportions can mislead us by unduly influencing volume. For example a market maker may trade a large delta neutral spread put spread that at naked glance makes the puts look far more active than they really were.
If 1000 traders each buy a single call option while one large market maker or broker/dealer buys 1000 puts then the p/c would be an exact 1.0. Those one thousand small traders buying calls tells us a great deal though about the bullish sentiment of retail traders.
In p/c terms, their over-hyped activity would be negated by that lone large put trade. Also, volume alone doesn't tell us whether retail traders are buying options in anticipation of a move higher or if those traders are selling options that they had purchased earlier. Certainly we could track open interest for clues but once again we have no idea if changes in OI are reflective of mass activity or just a big order or two.
The ISEE index
In response to some of these pitfalls the International Securities Exchange (ISE) publishes their own modified version of the put/call ratio called the ISEE index.
Unlike the old school p/c ratio the ISEE filters out trades from both market makers and broker/dealers. The ISEE further differentiates itself by using only opening long trades in it's tabulations.
As such the ISEE presents a much clearer picture of how retail options traders are positioned. The ISEE also uses a different equation than the regular p/c in calculating their index. To formulate the ISEE, the exchange takes the modified call volume, divides it by the put side and then multiplies the result by 100. Hence the ISEE is always a whole number.
With a normalized p/c equation a higher reading symbolizes greater put activity to calls while the ISEE formula generates higher readings if call buyers outweigh put buyers. So while a traditional p/c ratio of .75 would mean more puts than calls an ISEE value of 75 is the exact opposite. Like the CBOE the ISE also offers updated calculations of their p/c index several times an hour.
We can use the ISEE as a Trading Tool. Below is a chart plotting ISEE values over the past year. We'll smooth variance by including a 10 day moving average.
Now let's compare our ISEE chart to that of the S&P 500 index.
As you can see, analysis of the ISE index is highly discretionary. On one hand we know that at some point zealous options buying will signal a turn in prices. One can readily observe how 2007's highs in both July and October were achieved at the same time call buying was at relative extremes. We also note gigantic levels of put activity coinciding with important spike lows in August, January and April.
On the other hand it's also clear that trends are fueled by traders positioning themselves via options. Notice how our 10 day MA of the ISEE has a tremendous correlation to the SPX. Thus we have a typical trading paradox. Markets can't rise without buyers; yet markets can't become overbought without too much buying. This is where art comes into play.
Fading perceived sentiment extremes is not a holy grail. For years I've tabulated football picks against the spread from as many as 100 prognosticators each week. If I see more than 75% of the sample picking the same team I bet the other way.
While my betting results are better than average there is a great deal of streakiness. Last season for example bookmakers suffered their largest losses in years as favorites kept on winning. One of America's top handicappers, Dave Tully of the Daily Racing Form, said not only did Vegas casinos get creamed on single game wagers but even traditional sucker bets like parlay cards were paying off big for retail bettors.
We saw the same phenomenon in the ISEE in the first two weeks this past January. Put buyers were in force while the market was plummeting over 15%. There can be periods when the public is quite right. But not for keeps.
Sentiment through observance of put/call ratios is one of my major tools. I monitor every conceivable sentiment indicator. In future articles we'll touch upon some practical usages of how to profitably combine sentiment with support and resistance.
Kurt J. Eckhardt has been trading since 1982 when he began his career as an active floor trader in the CBOT Treasury Bond pit. Kurt is President of Eckhardt Research and Trading and its subsidiary Agility Trading. Agility offers both individuals and funds cutting edge technical strategies along with high performance instruction. For more information go to www.agilitytrading.com or email Kurt at kurt@agilitytrading.com."
Now, from the ISE:- How to Utilize the ISEE Index When Trading Options, TradingMarkets.com, 6/9/08
- Indicator of the Week: ISE Equities-Only Sentiment Index, Schaeffer's Investment Research, 3/24/08
- Reaching Bottom with Bernanke's Help, Forbes, 1/14/08
- A Sign of Skepticism in the Market, Schaeffer's Investment Research, 1/10/08
- A Simple, Practical Use for ISEE Select, SentimenTrader, 4/2/07
- Contrarians are Smiling, MarketWatch, 3/13/07
- A Different View of the ISEE, Schaeffer's Investment Research, 2/16/06
- Moving the Market — Tracking the Numbers, The Wall Street Journal, 11/7/05
- ISEE on the Cake?, Barron's, 12/1/03"
"In a post that went up in November - My Mae Culpa - Not Paying More Attention to Optimism - I recounted my sins in terms of not paying attention to data and changing environments. Not wanting to repeat that same inattentive error, I have been running through some indicators to go along with yesterday's post - Percent of ETFs Near Oversold Levels Hitting Extreme Reading. This search took me back to the "All Equities Only" ratio of the ISE Sentiment Index (ISEE), which closed at 92 yesterday.
Readings below 100 are fairly uncommon and suggest skepticism, as this is a "call/put" ratio. (You can find the chart of the data here.) To put this in perspective I created the chart below which marks a blue diamond on days when the All Equities reading was below 100. There was a cluster of signals during the early part of the rally that began in mid-2006, but the rest appear to mark short-term bottoms.
The mistake I made in October was not paying attention to the change in the trend of the price action. Committing that "same" mistake again would mean ignoring strength if we do see a bounce.
<-posted by Nick Perry on 1/10/2008 1:07 PM"
I guess we're going down in the short run.
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