Small Specs vs. Professionals issues:
As far as I am aware, there are 4 reliable indicators to watch that would tell us what the Small Specs / the Public versus what the Professionals are doing:
1. CBOE P/C Ratios
2. NYSE SSR/PSR Ratios
3. NYSE Odd-Lot Short Sales Ratio
4. COT Data
Let's review (and I hope that I am NOT offending anyone by going to the basics, but sometimes it's good to revisit the very basics):
1. CBOE P/C Ratios
CBOE Put/Call ratio (brainchild of good old Marty Zweig) - options are a zero-sum game, as each options is a contract between two parties, the writer of the options and the buyer of the option, and only one of them can make money.
Who are the writers of the options? The vast majority of them are the floor traders / locals on the major options exchanges (CBOE, PSE, AMEX, etc.) - what is indisputable that the options floor traders are 100% hedged or flat by the end of the day, i.e. they try to make money by daily scalping the options and difference between the options price and the underlying asset, and DO NOT have outright "directional" positions. Someone of the Hedge Funds probably write the options as well, and they could perhaps be writing options while being unhedged, for example selling naked call or put. I will also allow that some Small Specs / Public may be writing options, but at most it would be covered calls (to get some extra return on their stocks), and imho that still a very, very small percentage of the Public. And I'd be very, very surprised if the Small Specs were writing covered Puts (and they virtually CANNOT write naked calls nor puts).
Who buys options? Granted, again, some Hedge Funds and the Large Traders could be buyers of options and taking directional bets (or more complicated strategies such as Butterflies) to try to profit; however, imho most of the options buyers are the lowly Small Specs (even though I do NOT have a definitive proof).
Hence, when there is a lot of interest in buying call and not in Puts, it means that the options buyers are extremely bullish, and hence that is a classic mark of a top because once everyone is bullish, that means that there are NO buyers left, and hence someone will start selling their positions to lock in the profits and then others will start piling on, and hence we go in the other direction.
Same things work with when there is a lot of interest in buying Puts and not much interest in Calls - hence, everyone is bearish, and there is no one left to sell anymore, so as the short covering begins, the market reverses and heads in the other direction.
So, since the Small Specs are the primary buyers of options, and the Professionals are the primary sellers of the options, P/C Ratios work really well when they reach extremes in signaling major tops and major bottoms.
Now, let review CBOE P/C data back to 1995 (that as far as my data goes);
Since 1995 to present, the average CBOE reading is 0.73, and the Median is 0.71.
Since 1995, here are the instances where both the 10-day and 21-day SMAs of CBOE P/C ratio exceeded 0.90:
Sep-98 - 4-4.5 year (and all smaller cycles) Low
Sep-01 - G2 80w (and all smaller cycles) Low
Jun/Jul-02 - G2 40w (and all smaller cycles) Low
Oct-02 - G1 4-4.5 year (and all smaller cycles) Low
Feb-03 - near G2 4-4.5 year (and all smaller cycles) Low
May/Jun-04 + Aug-04 - G2 80w (and all smaller cycles) Low
Apr/May-05 - G1 40w (and all smaller cycles) Low
Aug/Sep/Oct-05 - G1 80w (and all smaller cycles) Low
The point here is NOT necessarily to advocate for Hurst Cycles, but to clearly show that extreme high readings in CBOE P/C ratio SMAs are always followed by huge rallies in the other direction.
Conversely, the LOWEST readings recorded since 1995 in 10-day and 21-day SMA of CBOE P/C ratio were 0.42 and 0.43 respectively. Can you guess WHEN those readings were recorded? In March-2000!!!! (BIG SURPRISE)
Slicing the data in other ways, let's look at the CBOE P/C ratio during (1) the "Bull Market" i.e. 1995 - Mar-2000, (2) the "Bear Market" i.e. Mar-2000 and (a) Oct-02 and (b) Mar-03, and (3) the "Cyclical Bull Market" (for lack of better description) since Oct-02 (a) and since Mar-03 (b).
(1) "Bull Market"
1995 - Mar-00
Average 0.67
Median 0.65
(2) "Bear Market"
(a) Mar-00 - Oct-02
Average 0.70
Median 0.69
(b) Mar-00 - Mar-03
Average 0.71
Median 0.71
So, during the "Bear Market", the readings are a bit more bearish readings than during the "Bull Market", which is completely understandable.
However, most curious is the data for the "Cyclical Bull Market" (for the lack of better definition at this point) i.e. since Oct-02 and since Mar-03
(3) Cyclical Bull Market
(a) Oct-02 - Present
Average 0.84
Median 0.82
(b) Mar-03 - Present
Average 0.84
Median 0.82
What is most interesting is that NOT only are the Options Buyers (i.e. Small Specs) far more bearish during this "Cyclical Bull Market" then during the Bull Market (this is where VLA, NYA, and un-weighted S&P500 have all gone to NEW ALL-TIME HIGHS), but there are also FAR MORE BEARISH than during the actual (and very brutal) Bear Market from Mar-00 to Oct-02 / Mar-03.
So, in summary, imho, this is first evidence that the Public i.e. the Small Specs are EXTREMELY BEARISH right not just in relative terms (as the CBOE P/C ratio SMAs today are 0.87 and 0.81 respectively i.e. very, very high) but especially in historical terms as outlined above.
(The other 3 will be discussed in later posts.)
AI
