CBOE Option Data - What does this graph show?

This complex graph shows several relationships to stock prices as depicted in these plots. There are 4 plots. One plot represents the Standard and Poor's 500 stock index (SP500) daily close. This plot along with the others are linear plots. The second plot shows the total open interest of all CBOE contracts which represents the number of contracts open at the close of each trading day and does not represent the Dollar value of all options open. The third plot converts the daily CBOE Put-to-Call Ratio into a five day moving sum oscillator. The fourth plot compares the CBOE total put volume to the CBOE SP500 and OEX stock index put volumes.

What do these plots mean?

At 15-20 Million contracts per month, the affect of options on Equity prices can't be ignored and must be considered a factor in any analysis of future stock prices. This industry's affect and the mathematical principles that govern options play as large a part in the future direction of prices as do company fundamentals such as earnings. So here is a more detailed account of what each plot represents and how it relates to stock prices.

The second plot shows the total open interest of all CBOE contracts which represents the number of contracts open at the close of each trading day and does not represent the Dollar value of all options open. This figure includes Equity Options, Leaps, Stock Index Options as well as any other options traded on the CBOE. As you can see by saw-toothed pattern, the monthly effect of option expiration on total open interest is dramatic. The open interest rises throughout the month and the day after expiration a large number contracts expire leaving the total volume of options open for future months. As a point of interest, if you subtracted the number of contracts open the day before expiration from the number of contracts open the day after expiration you would have the number of contracts in millions that expired (i.e.: 86 - 66 = 20 million expired in July 2001). Also worth noting is the dramatic rise in the number of option contracts traded. Currently, the open interest is approaching the all time high of December 2001. In addition, you would think that December would be the time when most options would be closed. But as the plot shows, it is actually January when most options are closed. This annual event appears as a sharp decrease in open interest the day after the January expiration which is usually lower than the previous six months.

The third plot shows the traditional Put-to-Call Ratio as an oscillator. This plot takes the actual daily CBOE total put option volume and divides it by the daily CBOE total call option volume to compute the famous Option Put-to-Call ratio. This ratio is widely watched to gauge the interest in buying or selling and it represents the relationship of the number puts purchased to calls. Since it is a popularly watched ratio in the industry, we created a variation of his ratio by adding the most recent 5 days values and displaying this 5 day moving total. As each value represents the sum of the previous 5 days Total Put/Call Ratio. And to make the variation more pronounced, we multiplied each day's value by 8. The multiplier of 8 was arbitrary chosen so that the oscillations would be more easily seen using the scaling of this graph.

As seen on this graph, peaks in the 5 day sum of the Put-to-Call Ratio (labeled: TPCR5daySum*8) tended to correspond to SP500 lows. But there weren't any consistent levels that proved successful in producing profitable results without incurring significant losses. For example, if you waited for a value of 40 (using the right scale) to buy the SP500, the first observation is that you would have waited years for this signal since this ratio only reached this value of 40 for the first time in March 2001. The second time it reached this value was in September 2001. However, in September had you bought the SP500 when this ratio reached 40 the price was 1045. Unfortunately, had you purchased the SP500 at 1045 you would have had to sustain a drop to an intraday low of 944. This would have created a 100 point loss which is outside the normal stop-loss point range for investors. Therefore following a strategy of simply trading using a particular value would create losses. Another interesting point is that this ratio is fast approaching this value of 40 which we can observe rarely occurs.

Another interesting characteristic of this plot is to look at the horizontal levels. During 1999, this oscillator ranged between 18-25. Now in 2002, the range is 30-40. There was a clear shift in the range of the Put-to-Call ratio during the fourth quarter of 2000. Since then there have been consistently more puts purchased each month. This makes sense given the downward trend in the Market since the fourth quarter of 2000. Remember that since the ratio is puts to calls an increase in put options increases the value of the ratio while more call options decrease the ratio's value.

The fourth plot is one that we created to discover any unusual option activity. This plot represents the ratio of the CBOE's total put volume (all options traded) to CBOE's Stock Index total put volume (only SP500 and OEX). This ratio (labeled: TotalPutsSXOXpRatio) is then added to the previous 10 days for a total. It is this 11 day total that is plotted. (BTW, he reason for using 11 days was to represent 1/2 of an option cycle.) This oscillator shows the relationship of all CBOE puts to the number of stock index put options. And since the average investor doesn't trade options this ratio is considered to reflect the sum total of professional investment activity which we equate to Institutional Activity. After watching this ratio for some time, we have deduced that this ratio is an "Insurance" indicator. It seems to be measuring the amount of insurance (put option volume) the financial industry is purchasing to protect its investments.

There are two reasons to buy put options and the put volume represents the sum of these two activities. 1. Purchasing puts represents buying insurance to protect one's profit. 2. Purchasing puts also represents selling the market short. Together, these two activities set the barometer's gauge of how confident investors are in higher prices. If professionals aren't buying puts for the purpose of insurance or selling the market then they're more confident of higher prices - Bullish. However, this isn't so simple.

We found extremely heavy put buying between July 2000 and July 2001. Although Wall Street is famous for being eternally optimistic, Wall Street does turn sour on the Markets even though they never tell the public. As a matter of fact, look at the TotalPutsSXOXpRatio plot during the year 2000. The ratio sky-rocketed during the second half of the year to reach levels greater than 100 (right scale). This means that there was 100 times more CBOE put volume as compared to stock index put buying. The professionals were buying insurance and in a big way. But did your financial advisor or brokerage firm advise you of increased risks in the Market? No they didn't. As a matter of fact they were spewing out the old "buy and hold" theory. Their advice was to buy a good company and stay in it for the long haul. Their mantra was to tell you to buy even though they were nervous enough to buy more puts than ever. Now, of course, where are we? Lower prices.

Another interesting point is that the TotalPutsSXOXpRatio is now the lowest that it has been since March 2000. So what does this mean? It's only speculation but we think that the "Big Money" is out of the market. They first protected themselves with the buying of puts back in July of 2000. Then they waited to see what direction the Market was heading and when the Market broke down and cracked, they sold their shares. But when they sold their shares they didn't lose much money because they had purchased insurance and protected their gains. The next down wave brought more put buying and increased speculating. This time hey were right when in the first quarter of 2001 the Market erased the gains of 1999 and 2000 and made new lows. The next spike in the ratio came in July of 2001. Just two months before 9/11. What's noteworthy and remarkable about this spike is that the ratio created a spike while the Market was declining whereas during the previous spikes the Market was rising. Was this insider selling? We'll never know, but one fact is clear. While Wall Street was telling the individual investor to buy, they were without a doubt covering their positions with puts and selling their positions to unsuspecting investors. Lastly, the reason that there is no spike in the ratio now is because the "Big Money" doesn't need to buy insurance. They've left the "party" and if you look at the US Dollar these days, they're even leaving the country. They are now in cash or short term LIBORs and are positioned for the next investment opportunity which will be in assisting Governments around the World managing their debts. The next opportunity will be the greatest transfer of wealth the world has ever seen since the level of debt around the Globe is larger than the World has ever seen. There is no other period in history when debt was so commonly used and accepted. Throughout the ages debt was considered the financial option of last resort but now Western culture has now totally flipped this perspective. We now purchase goods routinely using credit without any consideration to whether we have the funds to pay the debt and banks are constantly selling us more debt.

So who's left to bid up stock prices? No one. The "Big Money" has left and individual investor doesn't have any more money left to invest. The "Baby Boomer" demographic which was the "rocket" engine of the 1990s has banked their retirement savings in the Stock Market and they can't get out without incurring a loss at these levels. And as for the remaining younger "Baby Boomers" (at the younger side of the boom 1959-1964) still willing to invest, well let's just say that they don't have enough money to push the market around. Add to this the fact that companies are earning less and that consumers are spending less and you begin to see the picture that's developing.

Another aspect to this graph are the three vertical lines. They correspond to two market tops and one TotalPutsSXOXpRatio spike represented by these three dates: 9/2/00, 2/2/01, 7/2/01. What's remarkable here is that in each of these instances, the relationship of options to market prices was different.

Back in 9/2/00, the SP500 made it's last peak above 1500. If we consider only data leading up to this date, option total open interest was at record levels but the TotalPutsSXOXpRatio ratio wasn't. As the graph shows the ratio of puts to stock index puts had dropped backed to 63 from 105. The "Big Money" purchased put options two months before the top and they didn't win this time. If you notice carefully they purchased puts in a rising Market expecting the Market to drop but it didn't. Then as the Market broke the trendline (connect the lows of 1999 to mid 2000) the volume of put option purchases shot up again to reach the 100+ ratio level. Also worth noting is that the TPCR5daySum*8 ratio was neutral at 19.8 with the range of the times defined as 21.5 to 17. So the when the Market was at a high, there were a record number of option contracts open but puts weren't heavily purchased and Put-to-Call Ratio wasn't extreme enough to push investors to one side of the Market or the other.

The next peak was in the TotalPutsSXOXpRatio ratio and it occurred around 2/2/01. Since the last Market peak, put buying during this 5 month period was exceptionally heavy as the TotalPutsSXOXpRatio plot shows. This time the Market was rising off the lows. The TotalPutsSXOXpRatio ratio spiked above 125 for its all time high reading. They were buying puts in stocks at a rate of 125 to 1 for stock index put options. But while they were buying puts the TPCR5daySum*8 was at 22 which was the low of the recent range of 22 to 32. And the last plot shows us that the total open interest had declined from record breaking levels seen in December 2000. So while a large number of option buyers left the market a new wave of put option buying began.

The last vertical line shows the last peak above 100 (right scale) in the TotalPutsSXOXpRatio ratio. But this time the Market was declining and the SP500 was around 1230 within the recent range of 1103 to 1315. The option total open interest was near record levels and the TPCR5daySum*8 ratio was also at the low of it recent range of 24 to 32. Once again the key to future Market prices was the excessive put buying.

The professionals have long followed the Put-to-Call Ratio. And it is commonly understood that when this ratio gets to high, expect the Market to rise or bounce. And conversely, when the ratio gets to low, expect prices to fall. Currently, we are at historical high levels. Which empirically implies a bounce in Market prices. And if we were to follow the empirical data, this third peak of record high Put-to-Call Ratio levels would imply a fast recovery in Market prices, or a strong bounce up like we saw in the Spring and Fall of 2001.

The difference this time is that there is no massive unwinding of put options which occurred the previous two times. The previous two times the TPCR5daySum*8 ratio peaked at 40 or higher. The TotalPutsSXOXpRatio ratio peaked above 100 two months earlier and the Market dropped precipitously. So the sequence of events of extremely heavy put buying (or insurance buying) lead the market lower and when the Put-to-Call Ratio reached record levels the Market bounced quickly and strongly higher. This time the TotalPutsSXOXpRatio ratio is extremely low while the Put-to-Call Ratio is at record levels. This record Put-to-Call Ratio level implies a strong bounce, but since the TotalPutsSXOXpRatio wasn't at record levels 2 months prior to this decline. There isn't the fuel to cause the strong bounce that most investors are expecting. Hence, the bounce from these current levels 6/21/02 will be meager at best and the market will break these low prices and attempt to find support at 1997 SP500 prices 870-900.

In other words, the previous two times that the TotalPutsSXOXpRatio ratio peaked above 100 indicated that Mutual Funds and other institutions were getting ready to sell their positions. They purchased the put options before they unloaded their stock positions thereby guaranteeing themselves that they wouldn't lose any money by influencing the price of the stock downwards with their massive sell orders. While other investors lost money due to falling prices, the "Big Money" was merely selling out large volumes of stock and locking in their price using puts. After they completed their transactions the Market snapped back quickly and violently 200 SP500 points. This time the Put-to-Call ratio is signaling a bounce but this time there isn't a massive unwinding of put options to cover.

While the graph shows that there are currently 95 Million open option contracts on the last day of the June Expiration and that the level of options is steadily rising, it doesn't specifically show the Stock Index option levels. Suffice it to say that the levels of Stock Index Options are also rising. So while the ratio of Equity option puts to Stock Index option puts is declining, the overall level of Stock Index options is increasing. This equates to increased nervousness on the part of the professional investing community. And if they're nervous, watch out for how fast they'll all rush for the exits.

Last Updated on 6/23/02
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