ETFs, Market Timing|August 24, 2010 4:07 PM

Options Traders Call for Market Selloff

The CBOE Equity Put/Call Ratio hit the lower extreme on Monday, which means there were an extreme number of calls purchased relative to puts. Based on the contrarian viewpoint this is a strong sell signal on the markets. In my view, I’ve found the Equity Put/Call Ratio (EPCR) extremely valuable in helping define short-term tops and bottoms.

Of all put/call ratios the EPCR is the best to use because it only looks at equities and excludes options traded on indices and ETFs (including inverse)—this provides a direct look into what market participants are thinking.

The CBOE provides this info for free on their website but the hard part is tracking this on a daily basis and defining the upper and lower extremes. I use Bollinger Bands to define the extremes. It’s simple a spike above the upper band is extreme fear (market bottom) and a spike below the lower extreme signals complacency (market top).

Here’s yesterday’s chart – you can see that complacency was reached with a reading of 39%! Historically, any level under 55% is considered complacent. The last time the EPCR was recorded at this level was on April 15, 2010 and that was an excellent short signal (on chart below).

CBOE Equity Put/Call Ratio (click to enlarge)

Trade well,

Andrew Hart – ETFTRADR

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Author: Andrew Hart Andrew Hart is the portfolio manager and editor of the ETFTRADR recommendation service, ETF Elements and the newest ETFINVESTR newsletter. Andrew draws on his more than five years as a professional in the financial industry and lifetime of active involvement in trading to determine which sectors would be the most profitable to trade. Andrew Hart employs different trading techniques for different asset types; his disciplined systems are based on efficient growth. He believes technical analysis is paramount in all trading scenarios, and by using multiple indicators Andrew has a way of figuring out how all of the ETF pieces can be arranged for maximum profits. Andrew enjoys his work because it gives him the opportunity to teach, research, and achieve goals in ETF options. With a lifetime of financial interest Andrew has turned his passion into a career. He thrives on the success of his students and is always looking to pass on new tricks of the trade.

Joseph

In case you are interested, you can check http://www.le-projet-patrimoine.fr/p/IS/chart.php for a tool that maintains the PCR for you. You can configure the upper and lower bands, moving averages etc, and zoom in by click-and-dragging over the graph.

http://etftradr.com ETFTRADR

Joseph, thanks for sharing that with everyone – great resource. You can
also get this chart at StockCharts.com – simply use the $CPCE symbol, but
beware I notice that the current day’s info is almost always off a bit.

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http://etftradr.com ETFTRADR

Jeff, thank you for the GREAT information – that was an incredible
amount of calls traded on ATVI and if you reduce the put/call ratio to
incorporated the average number of calls traded on ATVI it raises to
around 60% (not an extreme).

It's interesting that the ISE calculation was NOT skewed. We follow
this too but I've found the CBOE ratio to be more effective in the
past. In April both the ISE and CBOE EPCR spiked to extremes, so that
remains the best signal.

Thanks for pointing out the ATVI calls, it reminds me what a great
program livevol is!
http://pulse.yahoo.com/_5IN5YRJS22TVQWRQLKXUVK5XP4 Jeff Linderman

The CBOE reading is False. A non-bearish mega-spread trade went on in symbol ATVI. Completely distorts the put call ratio. See link: http://livevol.blogspot.com/2010/08/atvi.html

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Price Headley was inducted into the Traders' Hall of Fame in 2007 and is the founder of BigTrends.com, which provides investors with specific real-time stock and options strategies and investment education to profit from significant market trends.

Price appears regularly on CNBC, Fox News and Bloomberg Television, and in a variety of print and online financial news outlets, including The Wall Street Journal, Barron's, Forbes, Investor's Business Daily and USA Today. Price also speaks regularly to investment audiences nationwide.

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