Option Investor
Market Wrap

Market Sentiment Indicators

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I want to take this opportunity to clarify that the bias suggested in the newsletter refers to the broader markets and not the indicators. Each indicator is independent and helps to provide some insight into investor’s psychology.

The Put/Call Indicator

We look at the CBOE Equity Option Volume Put/Call Ratio to determine the level of put volume being traded versus the level of call volume. Generally higher put volume suggests bearishness in the market as investors begin to hedge long positions and speculate on further declines. There is usually a point of inflection that determines that mostly everyone that was going to hedge has done so and the Put volume retracts to indicate that the market has possibly reached a bottom. We look for the masses to throw in the towel before buying and throw everything, including the kitchen sink into buying the market before selling. We look to trade the opposite of the herd mentality. But we have to be patient and wait for a confirmation from a reversal of some sort. For the Put/Call Indicator, we use the 10 and 20 day moving average to help provide some clarity to the choppiness of the indicator. While the Put/Call ratio generally cycles between 0.50 and 1.00, the 10 day moving average signals bearish from ticks below 0.65 and bullish from ticks above 0.85. From time to time, the range is readjusted to reflect the short term skew of option investor’s trading tendencies. For instance, the Put/Call ratio is skewed upward to reflect more option traders hedging their portfolios. In fact, this bearish skew is contrarian in that it indicates more people buy portfolio protection near the bottom. The overly cautious investor is hedging a portfolio that has already declined 40 - 50%. Therefore, my interpretation of the Put/Call Skew is to be Positively biased on the market.

[Image 1]

Earlier in the week I sent out an alert to point out that the Signal had been changed to a Negative bias. This was because the 10 day moving average crossed above the 20 day moving average. The lower volume trading is possibly throwing off the indicator because the 10 day has curled downward to almost cross below the 20 day moving average while the S&P has declined five straight days. I am going to a Nuetral Bias until the 10 day moving average retests 0.70 or curls upward. As of last night, the 10 day moving average closed at 0.737 while the 20 day moving average closed at 0.735. SIGNAL: NEUTRAL BIAS

Volatility Index Indicator [Image 2]

The CBOE Volatility Index has come down 50% off its high of 96.40. It should be noted that there hasn’t been any new regulations to provide order to the market. I would like to see the SEC put the uptick rule back. Without that, 96.40 doesn’t have to be the high. But for now, the range of the $VIX is bound by the 200 day SMA at 34.16 and the upper Bollinger band at 69.93. Even though the VIX moved higher yesterday, the $VIX 10 day SMA (blue line) continues to decline. A downtrending moving average is a bullish indicator for the $SPX. It is the reversal that determines either a Neutral or Negative bias. If the $VIX advances up to the 10 day SMA while the indicator is still Positively biased, you may want to add Positive deltas with new money. It should be noted that contrary to its historical inverse tendencies, volatility has been dissipating while the $SPX has declined.

Investors Intelligence

The Investors Intelligence polls that are released each week represent a sampling of newsletter writers’ market bias. The polls show the percentage of investment newsletter writers that are bullish, bearish and calling for a correction. We try to determine the crowd’s psychology by looking for signs whether the masses are extremely bearish or bullish. When signs of either of these occur they help define a buying or selling opportunity.

[Image 3]

Finally, the Bullish percentage of advisors decreased below 40% to 38.3%. The Percentage of Bullish advisors decreased to 35.1% from 26.9%. As the chart shows, the spread between the Bulls and Bears increased substantially. It moved up 17.2% higher to 3.2%. However, the spread is still below 0 and remained so since August. The signal remains on a Positive bias. SIGNAL: POSITIVE BIAS

SUMMARY: The $VIX indicator continues to maintain its consistent signals and is still Positive while the Put/Call Indicator is Neutral. The overall signal is a Positive bias (+ + -) for the $SPX and Dow Jones, but you may choose to wait until the $VIX spikes to the 10 day moving average before entering any positive Delta trades.

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