Sunday, June 19, 2011

A contrarian view ......

Interestingly, after my last blog entry I saw that the 10 day smooth moving average for the put/call ratio was at its highest it has been since March 2009 when the S&P put in its 666 low.

As a reminder, the put to call ratio is a popular contrarian indicator based upon the trading volumes of put options compared to call options. The ratio attempts to gauge the prevailing level of bullishness or bearishness in the market. Obviously, there is always a buyer for every seller, otherwise the market wouldn’t clear. On days when the major averages perform strongly, the number of calls bought typically far outweighs the number of puts, so the ratio tends to be small. On days of market weakness, fear prevails and the number of puts purchased is typically much higher. The daily put/call graph is highly erratic, however, a moving average that smoothes out the data is an excellent contrarian tool that can help you avoid getting caught up in the prevailing market sentiment.

A 1 day rise in the indicator is typically a sign that investors are temporarily seeking protection against a market decline, an extreme high in the moving average reveals a more comprehensive sentiment build-up. The put/call ratio hit its highest level in the last 2 and a half years, higher than this time last year when the market first plunged on Greece, and higher than March 2009 when the market hit the 666 low.

I always like mentioning the other side of the coin too, and so yes, this is a favored contrarian tool, never before has the put/call ratio been at such extreme levels DESPITE the multi-trillion safety net in the form of central banks, and just 2 weeks prior to the end of the Fed stimulus program. Contrarian tools are a good bet against conventional wisdom. However, with Greece/Europe on the verge of bankruptcy, perhaps conventional wisdom (continued declines in the markets) will prevail after all!!!

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