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SENTIMENT JOURNAL: Wary Investors Turn to Puts for Protection
By Frederic Ruffy, Optionetics.com
3/25/2005 8:45 AM EST

http://optionetics.com/articles/article_full.asp?idNo=12139

Market Internals: Stocks remained under selling pressure during the latest week of trading. In fact, the Dow Jones Industrial Average ($INDU) fell on four days during this holiday-abbreviated week of trading. Volume was lackluster on Thursday because many traders left early to enjoy the holiday weekend, but market internals on the New York Stock Exchange [NYSE] were extremely poor during the first three trading days of the week. For instance, notice from the table above, NYSE advancing issued trailed declining issues nearly three-to-one on Monday through Tuesday and nearly four-to-one on Wednesday. No contest between up and down volume during those three trading days. Clearly, investors have not been in a buying mood lately. The NYSE New High New Low Index slipped to –141 on Wednesday, compared to +13 on Friday.

The Nasdaq Composite Index ($COMPQ) moved less than a point during three of this week’s four trading sessions. Volume was light and the composite index lost approximately 16 points on the week. Market internals were mixed, with up volume beating down volume during three of four trading days. Is money beginning to move back into tech? It’s too early to tell, and the technical action on the Nasdaq Stock Market still leaves a lot to be desired. For example, advancing issues trailed declining issues during three of past four trading sessions. Nevertheless, Nasdaq stocks held up much better than their NYSE counterparts since last Friday.

Sentiment Data: The bears are really beginning to growl as the stock market continues to slip from one day to the next. The most obvious sign that investors have turned defensive or bearish is the Chicago Board Options Exchange [CBOE]. It has risen above 1.00 during six of the past eleven trading sessions. When this ratio rises above 1.00, it indicates that more puts traded on the CBOE when compared to calls. The last time there were so many high readings from this indicator was in October of last year, which also happened to be an important market bottom. The ten-day average of this ratio is now 1.00 and its highest levels since May 2004. Therefore, from a contrarian view, the spike in the CBOE put-to-call ratio is a bullish sign. It indicates that investors might have overreacted and that stocks are oversold. (For more on this ratio, please see Index Intelligence: What’s Bullish About the CBOE Put/Call Ratio? March 24, 2005.)

Similarly, the International Securities Exchange Sentiment Index [ISEE] fell to multi-month lows on Wednesday. This indicator is computed as call buying divided by put buying on the International Securities Exchange [ISE] multiplied by 100. The ISE now the largest US options exchange. When the ISE Sentiment Index declines, it indicates that call buying is declining relative to put buying. Wednesday, it fell to 119 and its lowest reading since October 2004.

However, while the CBOE put-to-call ratio and the ISEE are consistent with high levels of bearish sentiment, and have moved to levels witnessed during other recent market bottoms, it might be too early to conclude that investors have capitulated. For one, other indicators are not pointing to extreme bearishness. For example, volume hasn’t been running exceptionally high, which would normally occur during a period of capitulation. In addition, the CBOE Volatility Index ($VIX) is not far from where it was one week ago. It rose from 13.14 to 13.42 in the latest week of trading. When the market bottomed in October, the market’s so-called fear gauge was near 17.00. The latest surveys of investor attitudes are not consistent with capitulation either. For example, the most widely watched survey by Investors Intelligence shows 53.6% bullish and only 27.8% bearish, which is better than last week (54.4% vs. 24.3%), but not consistent with extreme bearish sentiment.

So, rather than trading the market aggressively one way or another, traders might want to look at specific sectors or industry groups that have developed a bullish or bearish bias. There is a chance now that bearish sentiment has risen far enough to set the table for another rebound like in May and October of last year. Indeed, some of the sentiment indicators are returning to those levels. However, a more legitimate bottom can be formed if the bearish sentiment stays high for several weeks or months, but that, of course, would also mean that stocks fall from here.