Sunday, March 29, 2009

Sharp Decrease in Buy to Open Put Options Last Week

In recent weeks I have discussed how put/call ratio data has shown complacency in that the ratio of put to call volume had not become very extreme on the Feb-March decline, and the ratios have been VERY low on the recent advance. Today I wanted to talk about another way of looking at put and call purchases. has an indicator that looks at the amount of calls and puts that were purchased by small traders as opening transactions. Small traders typically provide good contrary signals at extremes. The importance of looking only at buying transactions to open a position is that you can be sure that the traders are bearish when they open a put position and bullish when opening a call position. So looking at the data this way filters out the "pure" directional bias of less sophisticated traders that historically are most bullish at market highs and vice versa.

What the data shows from this past week is that opening put purchases dropped sharply to levels only seen at previous intermediate tops in this bear market. The current level is on par with the May 2008 and Oct 2007 tops, though not as low as in January of the last 2 years. Call purchases have not risen to troubling levels at this point but the message is clear enough.

Taken together with recent put/call volume data and historically extreme breadth readings, it seems that we should be very close (couple days to a couple weeks) to a significant retracement of the recent market rally.

This week I will be looking for a good opportunity to recommend a purchase on BGZ again with a multi-week or multi-month holding time frame to try to make a large gain on what I expect to be another fierce decline in stocks in coming months. The last trades on BGZ were modestly profitable, but the rate of decline never picked up to the level which justified a longer term hold. It often takes several tries to catch a major trend shift, so it is important to remain alert as as any large price pattern looks to be completing.



  1. i'm looking forward to this trade pete. any reason why bgz over tza? i know you've been thinking strong move down; does this still hold? just wondering since you are picking trip etf's, which can be a little tricky if you get caught on the wrong side of an inverse.

    i did decide to sit out the last sds trade as the market seemed to have some indecision last week on what it wanted to do; but very good call on the sds trade.

  2. b,

    I don't have any specific reason for BGZ over TZA. Both would get the job done. My goal with the blog is the give good consistent entries and exits by integrating a quantitative approach with a pattern recognition and logic oriented approach.

    I don't put much time into comparing performance of small caps to large caps, etc. So certainly feel free to choose among comparable funds if you think another is a better choice.

    I do think a very strong move down is on the not too distant horizon. I will repost a post I made near the January highs (warning that it was not safe to enter the market long term yet) explaining a historically consistent way to "know" whether the bear market is over or not.

    Unless the 880 level is exceeded on the S&P, the bear market is absolutely still active from my perspective.

    As an aside, I plan to make a trade on far OTM put options rather than buy BGZ to take advantage of the coming decline. I will likely buy the 60 strike puts on SPY (May or June probably, but still need to see a little more action to get a better idea of how close we are to the end of this last phase of correction).