Stock Market Indicator Shows Strong Bullish Sentiment
Anyone needing more evidence that the stock market is bullish and doing well right now should just take a quick glance at the popular market sentiment indicator, the put/call ratio. Because this indicator generally lags the market and may not tell the whole story, it may not be the best gauge of sentiment. Still, though, it can certainly give some valuable insight into how investors overall may be feeling (or fearing) about the market at any given time.
What is the Put/Call Ratio?
The put/call ratio is a simple calculation that compares the trading volume of put options to call options. In a quick nutshell, put option holders have the right to sell a security. And call option holders have the right to buy a security. This generally means that puts are an expression of bearishness (expecting the security to go down in price). And calls are an expression of bullishness (expecting the security to go up in price). Of course, it’s not really this easy, as options are used for more than just expressing bullishness or bearishness. They’re also used as income, insurance, and to hedge other positions. But we’ll keep to this definition for now.
The put/call ratio is derived simply by dividing the number of traded puts by the number of traded calls. Clearly, if there are more traded puts than calls, the ratio will be above 1. And if there are more traded calls than puts, the ratio will be below 1. So one way to look at market sentiment is as follows:
- Put/Call Ratio > 1 = Bearish
- Put/Call Ratio < 1 = Bullish
The CBOE Put/Call Ratio
The Chicago Board Options Exchange (CBOE) is the largest options exchange in the U.S. It publishes a total put/call ratio that includes options on individual stocks, ETFs, and indexes. This provides an overall view of market sentiment from the perspective of the options market.
The chart above tells the story. The big spike back in late December corresponded with the disastrous drop in the markets. It was the largest spike in the put/call ratio in nearly nine years. As panic ensued, investors bought and traded put options feverishly, boosting the ratio to extreme highs.
But look where we are now (as of the market close on 2/15/2019). As the market continues to rally, the put/call ratio is far under 1 and near its one-year lows. Does this mean all is good and the market will continue to rise? Maybe, but not necessarily. Some investors use the put/call ratio as a contrarian indicator. When the ratio is low, contrarians may see the markets as too bullish and complacent. And they may therefore look to sell. In the same vein, the late December put/call spike was a contrarian signal to buy the market – and it worked.
So should we be bullish or bearish on the rallying markets right now? Of course, we can’t tell you what to do. But the put/call ratio certainly merits more research and consideration as an indicator of market sentiment – whether you’re a trend-follower or a contrarian.
IMPORTANT: The information above should not be construed as investment advice and should not be considered as a solicitation to buy or sell securities. Trading and investing in the financial markets involves substantial risk of loss, and may not be suitable for all investors.
Disclosure: At the time of this article’s publication, we have no position in any security or trade/investment mentioned, nor do we have any business relationship with any company whose stock may be mentioned.
Senior Technical Analyst at The Technicals
As a momentum stock trader, Luke focuses mostly on strong market moves. Luke has been trading the markets since the early 2000s, but still gets excited by big movers. Whether a surging large-cap tech company or meteoric penny stock, Luke tracks and trades winners. A technical analysis purist, Luke authors many of our Top Stocks & ETFs reports. Contact Luke