Part 1: Index Options put/call ratios
Option World: Specific statistics and details for each individual contract month
Legend:
The CBOE put/call ratio represents the CBOE exchange's total put volume divided by the CBOE's total call volume. However, this widely reported value may not reflect the nuance of a particular index. So we have probed into the CBOE's data and determined each individual index option's put/call ratio. Below are the put/call ratios of the CBOE's top 5 most active indices.
Below are the composite put/call ratios. We use the term composite to mean the sum of all puts and calls traded in all actively traded contract months. This produces one aggregate put/call ratio for each index option. In addition, each individual index option trades many different contract months simultaneously and each contract month can have its own put/call ratio. For a detail of each contract month ratios, visit our Option World.
Part 1
Below are graphs of the indexes listed above. Each chart shows the index's daily closing price along with the daily composite put/call ratio. Notice the difference between the CBOE put/call ratio and the index's put/call ratio. As you can see, the SPX's, NDX's, and the DJX's have consistently higher values than the CBOE's. A higher put/call ratio means that more puts were traded than calls. Naturally you'd think that this means that traders are betting that prices will go lower but that it's the case. They may be willing to spend a little money now to lock in existing profits against any unforseen market declines. They may be buying puts to create a synthetic future or they may be just simply betting on lower prices. Remember options serve other roles besides leveraging your money (controlling more assets than you can actually own): insurance and hedging. As a matter of fact, more put options are purchased as insurance or as a hedge than as a pure market play. So this means that put buyers spend money for reasons other than the market going down.
It's interesting to note that during the 25 days prior to the September 2003 option expiration, the put traders lost big and you can see the ratio fall from high levels to low levels.
As for the OEX option traders, they seem to know when to sell. When the put/call ratio rises in the OEX, then it's time to sell because this data is more highly correlated. It's interesting to note that this investment vehicle was the "King" of index options. But in recent times, the volume of this index has slowly diminished and it is no longer as popular as it once was. As a possible theory as to why the OEX seems to be more highly correlated than the other index options, perhaps the crowd is following the "fads" and the hard core professionals are the only traders left trading this option.
Interestingly, out of all of the index options illustrated here the one market with the highest correlation is the XAU. These option traders seem to be all over this market like a wet suit. Their accuracy is remarkable and so these traders should be watched. More calls are traded when prices drop and more puts are traded when prices rise.
Notice that I refrained from saying that they are buying more calls as prices drop and selling more puts as prices rise. This is because in the option market there are a number of possible transactions. You can go long or short on puts and calls; you can buy and sell covered or uncovered positions. So for example, a trader wants to buy a call option, there has to be someone willing to sell it to you. If there's was another option trader who purchased a call at a lower price and sells it to you then a long position was transferred to you and the original seller is still holding out for lower prices or is hedging against another position. However, if at the time a trader wants to purchase a call option and there are no call options for sale from previous call buyers, a floor trader will sell you a call. Basically, he will create a new contract. The trader gets to buy a call option and the floor trader is now selling you a call. The only meaningful conclusion that can be made from these data is that the volume of puts and call increases as prices either rises or falls. In the XAU index option market the volume of calls increases as prices fall and the volume of puts increases as prices rise. Currently this market is characterized as an orderly market. Things are reacting as one expects. But this week 9/17/03-9/19/03, the behaviour is changing.
Hopefully now you can understand why a change in behaviour is important. The scenario above explained a change in ownership. If there are no call option buyers willing to sell their options in a rising market, the floor trader has to step in and sell call options to meet the demand of the market. But when the floor traders need to risk their own money to do this, the call option volume increases as prices rise. If floor traders are selling calls and prices rise they lose money. So they are only going to risk their money when they are reasonably sure that prices are near the top.
As you follow the series from May 2003 to September 2003, you can see how the XAU traders have changed their stance and hence their reactions to prices. The put volume in May was greater as prices dropped and put volume increased. Also notice how quickly the ratios flipped from one side to the other. Then in July you can see the switch. As prices dropped call volume increased. In May and June the increase in put volume as prices dropped didn't pay off. Prices went against them, but notice that for a six week period of time the XAU index prices didn't move. From the beginning of June to the middle of July XAU prices touched 74! This gave option traders time and opportunity to unload puts and switch to a new strategy which still was in effect until this past week September 15-19, 2003. Now the XAU put option volume is increasing as prices fall and call option volume is increasing as prices rise! During mid-July and all of August, call volume increased as the XAU dropped in price. Now that behaviour is changing. Typically when this happens, prices in the underlying index will stagnate so that traders can work their trades. This means that their will be time and opportunity to correct past mistakes and set up for the next leg of the market's move. For clue visit our Option World. and inspect the individual option contract months activity.
Another interesting observation is that in the DJX market, a spike in the put/call ratio occurred two days before the anniversary of the 2002 July low. Apparantly, traders were buying insurance against a sympathetic reaction to last year's patterns. The OEX traders increased their interest in puts just before USA's birthday and those puts made money, but the DJX options didn't. The Dow made lower lows three weeks later, but these puts lost money after the price premium built into the options was washed away by time and the two week rise in price. So this is an example of observing behaviour. Those heavily invested in the Dow Jones Industrial Average (DJIA) sought to protect their positions against a perceived risk rather than selling their stock in the DJIA. Notice the put/call ratio in August when the DJIA made a new closing low, the put option volume didn't increase at lower prices. As a matter of fact, there was more interest in call options than in put options. In addtion, the ratio of put/call ratio of the DJX was lower than the put/call ratio of the CBOE. This indicated that DJX option traders were more interested in calls than call option traders.
Notice the behaviour of the NDX option market. As soon as prices back off new highs, put volume spikes to the extreme. They seem to be a jittery bunch and they made some money; lost some money, and made some more. Their net profits swing wildly. Basically, the underlying bearish sentiment is still strong as all higher highs are met with increased put volume.
After you look at these charts, then let's look at how value affects these ratios. Click this link to see dollar weighted put/call ratios and the another ratio based on total option value to total option volume. Part 2: Option Value Ratios
created 9/19/03, ©2003 The Small Investors Software Co. All rights reserved.