Wednesday, May 20, 2009

Put/Call Ratio in a New Channel?

Upfront, I must say I don't know enough about this indicator, I don't use them regularly (it is considered a secondary indicator). I'm no TA expert and I don't even know the regular TA applies to this indicator. But the recent decline of VIX below 30 piqued my interest.

This is a weekly chart of CBOE Options Total Put/Call Ratio Index, over 3-year period. Put/Call Ratio is a gauge for market sentiment, and considered a contra-indicator. If the ratio is too low it is considered to be signaling over-bullishness and imminent market turn. If it gets too high it is considered bullish. It usually spikes up in market fear/panic.

Looking at the chart, however, I noticed that the March low happened when the ratio was trending down. After the low, the ratio kept going down.

I eyeballed the range for the most part of 3-year period between the green lines. The range between the blue lines is my eyeballing of the trend since last October, when the market started to crash in earnest. It's a down-trending channel to me, if that's possible. Could it be because of the popularity of leveraged ETFs, and investors don't use options as much these days? (Therefore the ratio doesn't give a meaningful enough signal?)

So I put 4 charts just showing the weekly volume of popular leveraged ETFs below the Put/Call Ratio chart: from the top, they are SKF (double short financials), UYG (double long financials), FAZ (triple short financials), and FAS (triple long financials). I picked financial ETFs, as the main cause of the severe market decline has been attributed to financial stocks. The down-trending Put/Call Ratio does seem to correspond to markedly increased volume on these leveraged ETFs.

It's also entirely possible that it is basing, and getting ready for a spike up.

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