How Investor Optimism Could Lead to an Underperforming Market

This indicator will be a cause for concern over the next few months

Senior Quantitative Analyst
Sep 23, 2020 at 8:00 AM
facebook X logo linkedin


Investors are on a call-buying spree right now, creating an extreme reading in the equity-only, buy-to-open (BTO) put/call ratio, which gauges the sentiment of option players. We get option volume from three different exchanges (the CBOE, ISE and PHLX), broken down by whether the options were bought or sold, and whether it was an opening or closing trade. We focus on the volume that is bought to open, because the motivations of the options buyers are clearer. As a refresher, call purchases are a bet that the stock will go higher, while puts are a bet that the stock will go lower (some volume is surely hedging, but we will assume it’s not a significant portion).

The Bearish Implications of Optimism

The chart below demonstrates what is explained above. The all-equity, 20-day BTO put/call ratio has fallen to an extremely low level, suggesting a lot of optimism for stocks. There are two main reasons that optimism among investors often leads to an underperforming market. First, it indicates that many investors are fully bought into the market, so there is less “sideline money” or buying power to push the market higher. Second, with so much money invested, anything that worries investors has the potential to create sharp selloffs as they scramble to exit their positions. 

 SP 20 day BTO

The tables below further support this argument. “I went back to 2014 and found times the 20-day BTO put/call ratio was extremely low, high or somewhere in between. I defined low and high as the lowest and highest 15% of readings since then. Then I summarized the one and three-month returns based on these groupings.” The current reading is extremely low, which tends to lead to an underperforming market. When the reading is low, the index averages a slight loss over the next month. Over the next three months, that becomes more severe, with the index averaging a loss of 1.73% and barely half of the readings positive. In simpler terms, this indicator will be a cause for concern in the weeks ahead.

SP 1 Month 3 Months

Sector View of BTO Put/Call Ratio

The table below breaks down the 20-day BTO put/call ratio of about 40 sectors. Below are the top 20 sectors by BTO volume, or the sectors that have the biggest influence on the overall ratio. The overall ratio is about 0.38, and the top three sectors (technology, retailing and software) have a ratio that is close to this.

The travel/leisure and pharmaceutical/biotech sectors both have low ratios, which indicates optimism. Investors seem to be betting on a bounce-back from the hard-hit travel/leisure industry. Perhaps the thinking is that things will soon open, and that demand will surge back for those services. The bullish bets in pharmaceuticals could be related to hopes of companies creating a treatment for COVID-19.

Finally, there are two sectors where the current reading is above the average. Based on those readings, investors look to be bearish on oil and telecom companies. If you are looking for contrarian stock plays, these are the sectors where investors are most bearish.

Sector 20 Day

 

Target Effortless Triple-Digit Gains Every Sunday Evening For Life!

This is your chance to triple your profit potential on Sunday evenings, without spending all your free time watching the market.

On Sundays, as a Weekend Plus subscriber, you’ll get up to 6 trades every Sunday, each targeting gains of 200% or more.

Start targeting gains like the ones our subscribers have seen recently, including:

213.3% GAIN on AutoNation calls
100.0% GAIN on Monster Beverage calls
100.4% GAIN on Walgreens Boots Alliance puts
100.4% GAIN on ON Semiconductor calls
257.7% GAIN on Dell calls

101.0% GAIN on Apollo Global Management calls
103.6% GAIN on JP Morgan  Chase calls
105.3% GAIN on DraftKings calls
101.3% GAIN on Airbnb calls
203.0% GAIN on Shopify calls
102.0% GAIN on Cboe Global Markets calls
100.9% GAIN on Boeing calls
102.1% GAIN on Microsoft puts
102.3% GAIN on First Solar calls
101.5% GAIN on PulteGroup calls
101.0% GAIN on Apple calls
209.4% GAIN on NXP Semiconductors calls
100.8% GAIN on Uber Technologies calls
100.4% GAIN on Academy Sports and Outdoors puts
102.2% GAIN on Trade Desk calls
100.8% GAIN on DoorDash calls
100.0% GAIN on Camping World Holdings puts
100.0% GAIN on Cboe Global Markets calls
100.2% GAIN on C3.ai calls
238.5% GAIN on Oracle calls

 
 
 


 
 

Rainmaker Ads CGI