Indicator of the Week: Is the Notorious Retail Crowd Wrong Again?

Despite being near all-time highs, the S&P 500 Index (SPX) still gets no love from retail options traders

Senior Quantitative Analyst
Apr 13, 2016 at 6:00 AM
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My article this week is a little different than what regular readers will be used to (if I have any regular readers). I typically take a very quantitative look at market returns and data, but this week I'm taking more of a qualitative look at the data and attempting to interpret what exactly it tells us about investor sentiment. Specifically, I'm looking at buy-to-open (BTO) option volume data we collect from three different exchanges: the Chicago Board Options Exchange (CBOE), the International Securities Exchange (ISE), and the NASDAQ OMX PHLX (PHLX).  

BTO Option Data: The option data I'm looking at is an aggregate of S&P 500 Index (SPX) stocks. It is buy-to-open data, meaning it only includes data initiated by the option buyer. This volume is easier to interpret. I'm interpreting call buying as bullish and put buying as bearish. Volume generated by sellers is often part of a bigger strategy and therefore not as easy to interpret correctly.  

Also, the volume is labeled as customer volume. It disregards the volume labeled as "firm," so it ignores buying by a lot of the big institutions to focus more narrowly on the retail customer. Retail customers are notorious for being wrong about the market. That is why it can be useful to gauge their sentiment. 

BTO Call/Put Ratio: The chart below shows the S&P 500 Index along with the 21-day call/put ratio on the stocks that make up the index. (FYI: the reason I often use 21 trading days is that it is approximately 30 calendar days, or one month). As I mentioned above, I interpret call buying as bullish and put buying as bearish, so as this ratio rises it means more optimism from the retail crowd, and as it moves lower it indicates more pessimism.  

You can see in the chart that the 21-day call/put ratio has rebounded modestly from its lowest level in several years, indicating that option players are very pessimistic on stocks right now. Pessimism from this particular group of investors is a very good sign going forward, according to us contrarians. 

SPX 21-Day Call Put Ratio 

This next chart breaks down the volume by puts and calls, so we can see exactly what is driving the ratio lower. The puts being bought to open look relatively stable over the past few years -- maybe a slight uptick. The calls, though, have a pretty clear trend moving lower. There has been some volatility to start 2016, but the fact is the S&P is less than 4% from all-time highs. The retail crowd is not buying back into this market -- and it's usually a good idea to do the opposite of what they are doing. 

SPX Calls Puts April 13



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