Equity Put/Call Ratios Spelling Trouble

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The chart above is the S&P 500. This chart is updated from a chart I showed about a month ago showing what pattern I believe has been forming over the last several months. There is really only one significant change. At that time I thought it was likely that a triple three correction was completing, however the market never made the kind of dramatic decline to confirm the start of a new/larger degree bearish pattern. As each passing day goes by, the picture becomes more clear for the future due to an ever decreasing amount of patterns that can form from this point. I had mentioned previously that the most common pattern to form at the end of a complex correction is a contracting triangle. That is the pattern I have projected on the chart for future expectations.

The purple box on the chart that I labeled "target zone" was the box I drew about 2 weeks ago in anticipation of a dramatic advance for the first leg up in a horizontal triangle. You can see that so far it has been a precise projection. From this point, I am not sure if the first leg up is complete or if there will be another push higher this week. Short-term models are oversold after a two day decline on lighter volume. That is usually a set-up I would take for a bullish trade, but I have some hesitation here because price will likely go much lower if the first leg up is complete. I will see how Monday morning goes before deciding on whether or not to make a trade here.

If the market is able to move to new highs, I will definitely be looking to recommend a bearish trade at the first good opportunity (I would like to see the 825 level exceeded). If the market continues to fall, I will look to make a bullish trade after about 50% of the recent advance is retraced. So stay posted tomorrow, as I may end up suggesting making a bullish trade, but with only half the dollar amount usually devoted to a trade. Then if the market continues to fall and we get another good set-up, we can add another equal size trade at a lower price.

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The next chart is one I have shown before which is the ratio of the 5 day average (1 week) of the equity put/call ratio to the 63 day (1 quarter) average. This tends to be a good intermediate term contrary indicator. What we are seeing is that the 5 day average has recently dropped to about 80% of the 63 day average. This is an extreme reading and shows excessive optimism in the options market. These types of readings can occur without the market slowing down when the market rises out of a bear market low. But if that is not the case (and I don't think it is) then price will usually have trouble making much more headway. While I have not shown the chart here, the 10 day to 126 day ratio is also currently at about 80% or 20% below "normal."

On a side note, if the market were somehow able to exceed 875 in the next few weeks, I would have to consider a change in longer term bearish perspective. That would not really affect blog trading recommendations, but as of now there stands to be a GREAT put option trade setting up if the approximate scenario above plays out.

Pete