Monday, January 5, 2009

Some Charts on Put/Call Data and Gap Sizes

Click on Chart to Enlarge
This first graph is a 2008 chart where I plotted the 5 day average of the equity put/call ratio divided by the 63 day average of the same data. Why those numbers? The 5 day data shows the average put/call ratio for the last trading week. There are approxiamtely 21 trading days a month and 63 per quarter. So the 63 day average is the average ratio for the last quarter.

When the 5 and 63 day ratios are similar the overall reading on this chart will be close to 1.00. That is would be completely unremarkable. But when you see recent data readings that are far from the longer term average (1.00), then you need to pay attention as these data tend to revert to a mean of 1.00.

In the current situation, the ratio is below 0.80 or more than 20% from 1.00 (normal). The last time we saw a reading this stretched was in early May of 2008 a little less than 2 weeks before the top of that bear market rally. I didn't plot standard deviation bands on this chart but the current reading is pretty extreme in a statistical sense. This indicates recent complacency relative to the longer term trend in put call data. That would indicate high risk of further market declines in coming weeks or months.

Click on Chart to Enlarge
This next chart is a plot I made of the cumulative gap % in SPY over the last 5 days divided by the sum of the absolute value of those % gaps. The highest the ratio can go is 1.00, and the lowest is -1.00.
When the reading is near 1.00 that means that almost all of the gapping done by the market over the last week has been to the upside. By looking at this data I was hoping to gauge whether this ratio is indicative of short-term exhausion in the past. The rationale is that gaps are largely created by novice traders entering orders for the next day and by news events which create short-term overreactions in light of the longer term picture.
As Friday's close, the ratio was 1.00. The last times the ratio reached this level were typically at short term tops and some at more intermediate term tops like in mid May 2008. This is yet another sign of potential short-term exhaustion.
Taken together with all the other indications from volatility, put/call data, breadth, etc. I feel like a short-term top will occur in the next few days, and this may be also an intermediate term market top.

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