Once 950 in the S&P 500 (SPX) was pierced, today's upside spurt should not have been surprising. Housing sales pick up, yes, but the bullish 'news' always seems to come out when it's 'supposed' to! More on this after a discussion on measuring market sentiment and how it can be used in trading.

I got a couple of e-mails recently from Richard, one of our OIN Subscribers, who wrote as follows below. (Note: I made some edits on some personal references, etc.) Please bear with me on this extensive reprint as it makes a couple of points, one explicit and one implicit, that are important regarding trading.

The obvious point relates to the importance of psychology in trading. This has been known 'forever' so to speak in the west and earlier in Japan. Charles Dow wrote about this first in the U.S. over 100 years ago, when he stated that bear markets (and bear market price swings or cycles) always end when 'everyone' and certainly the 'public' is very bearish. Bull markets and bull market swings always end with the average public trader or investor extremely bullish. The key to use in trading strategy then lies in HOW you measure and use bullish or bearish extremes.

The other implicit point is that THINGS AREN’T ALWAYS WHAT THEY SEEM! I use this call to put ratio in a non-standard way and have software (TradeStation) that allows me to create a 'custom' indicator by inputting daily data for it manually; and also to give that (custom data) item my own name. You can do this in your head, on paper or in Excel. More on that and why I keep this indicator in my own way after the e-mail comments:


"I want to say that you have taught me a 'Ton and still counting!' I find the CPRATIO indicator to be a very important indicator that I want to use it on my base chart template. I've learned to work with 3 or 4 indicators instead of a 'indicator overload' that was helpful and ALSO, too conflicting.

However, when I go to the CBOE website I cannot even find the DAILY CLOSE CPRATIO Ratio #, LET ALONE BEING ABLE TO VIEW IT ON A CHART. For example, it (the ratio) closed today at 1.65 as seen on your chart in tonight's article. On the CBOE website the closest Ratio was the equity P/C Ratio of .61

I entered the full name of the indicator in CBOE's Search box and got 0 result, I tried the abbreviation in Search, got Nada and I tried, 'display the close of CPRATIO' and got something but it was about contract assignments.

I don't use Trade Station; however, I use TD Waterhouse's high end trading station and TD support could not help locating the indicator let alone seeing it on a chart like their displayed in your articles.

Any suggestions on where I should go at the CBOE website or how to phrase an email to CBOE Support? I thought you may suggest other terminology that would get my request understood.

And thanks for consistently communicating your knowledge in a written manner that is "user friendly" in the way you explain technical knowledge to your Students or Subscribers!"

AND, after my explanation of how I keep up my version of the CBOE equities call to put daily volume ratio in my most recent weekend Index Wrap, Richard wrote this follow up note:

"Thank-you for explaining the CPRATIO indicator in regards to not finding it on the CBOE website and how to calculate this indicator.

As you said, 'I am always a student of the market'! I totally agree and your explanation will allow me to use this indicator as, or in the same way, as a price oscillator as well as confirming on other price oscillators. I've found it (this ratio) to help me make more accurate trade plans and when to execute them."


Market sentiment, or how bullish or bearish traders and investors are, may be important at extremes but how do you use this fact in helping make your options trading decisions? There are no hard and fast rules that I've found, but there are some guidelines.

Options specialists and traders noticed over years that when total call volume got to be about double that of put volume, it often marked periods of over-optimistic expectations about how much higher stocks would go. Conversely, when daily call volume fell to near that of daily put volume, traders were overly pessimistic on how much lower stock prices were going to get, at least in the near-term.

It somehow became a standard to divide total daily option put volume BY call volume and hence the put/call ratio (and a fractional number) started to be followed. There were two initial problems from at least my market mentor's perspective (Mark Weinstein, interviewed in the book Market Wizards).

One problem was that including index options call and put volume totals meant that these figures were 'distorted' by the sizable hedging activity going on. Rapidly rising prices could bring in sizable portfolio 'insurance' related activity as fund managers bought index puts. This, as opposed to more and more speculative call buying in individual stocks by individual traders which reflected bullishness.

The other problem was that when you plotted the put TO call ratio, the resulting graph didn't look like other 'overbought/oversold' type indicators, in that a LOW reading was bearish and a HIGH reading bullish.

So, a small group of us on the Street of Dreams began plotting the indicator the other way and keeping the resulting ratio first on paper than on computers. We found that just keeping the numbers on the CBOE alone was sufficient.

TradeStation software is one that I was managing for Dow Jones under license and sold across Europe when I was based in London. This software allowed me to create a 'custom' data item and give it any name I wanted. I could have called my indicator 'elephant' instead of 'CPRATIO' (Call Put RATIO) and manually entered the call TO put ratio everyday, but using the equities-only ratio.

I'll go back to the S&P 500 (SPX) chart first shown above and note the relatively high CPRATIO on this recent expiration Friday. This indicator was getting quite high along with the RSI indicator and other PRICE oscillators. However, notice how my CPRATIO indicator has backed off or fallen back this week pullback action bullishly and figure that my upside objective of (at least) 1020 will be met over time. There is a rising line of resistance I also see along the 'kiss of death' trendline, but this is somewhat secondary.

Why does ADDING the price difference of a trading range TO the upper end of the range (when pierced) work as a further objective. Or, why does high bullishness suggest trouble ahead?

On the first point, I don't know. It just seems to work. Buyers and sellers get into balance for many weeks or months and then some new dynamic comes along and there is a CHANGE in market expectations (psychology) and buyers find fewer sellers and off prices go to the upside. The next leg up seems to then at least equal the first leg up.

As to why the major indexes tend to get near a correction, often within 1 to 5 trading sessions, when the Call/Put ratio gets into the 1.7 to 1.9 range, or higher, it's just something observed over many years and many market cycles. The one thing that age offers as an advantage is that you see more and more market cycles. I use 'cycles' more in terms of characteristics and type.

Two other aspects are that heavy call buying tends to have MULTIPLE periods, so that the ratio (the way I keep it) can have 2 or 3 or more 1-day readings in the 'high' bullishness range seen above. (This is not so true of bottoms when there often is only one LOW extreme.) We got one such high reading Friday and I'd look for at least another such reading. Maybe prices back off some ahead, but it's likely that this current rally hasn't run its course yet. 1000 in SPX hasn't been challenged yet! BIG ROUND numbers are important; e.g., 9000 or (especially) 10,000 in the Dow and certainly 1000 in SPX.

The other practical thing to note is that going on the CBOE web site not only gives you a daily COMPLETED reading of that day's call and put volumes (and you can sign up for a daily e-mail summary), but you can check out the Intraday volume figures hour-by-hour and see cumulative totals. Going into the last hour of trading (between 2 & 3, Central time) will yield a good idea of how the ratio is going to end up for the day. This look still gives time to look at the equities call to put ratio, along with the other technical and fundamental aspects that are meaningful to you and still make a trading decision before the Close.

Also, when dividing the total call volume by total put volume do yourself a time-saving favor and drop the last 3 digits. For example, today's final intra-day equities call volume total indicated 2,025,853 (this number will change slightly at the 'final' tally, but not by much) and cumulative intraday CBOE put volume got to 1,309,603. Divide 2025 by 1309 to get a ratio of 1.55. I could see by the close that this market is not yet reflecting a throw-caution-to-the-wind bullishness.