The steep drop in calls seems like a bullish sign for contrarians
Option traders have bought fewer calls relative to puts of late. This is based on the 20-day equity only buy-to-open (BTO) call/put ratio. We get option volume data from three different exchanges (the CBOE, ISE and PHLX), broken down by whether it’s bought or sold, and whether it’s an opening trade or closing trade. Focusing on buy-to-open trades ignores the closing of contracts and trades initiated by sellers. The remaining volume we use to create the chart below is likely to be speculative buying, which allows us to draw straightforward conclusions about sentiment.
The 20-day BTO call/put ratio has collapsed as the market has pulled back. Diving into the chart below, there were also steep drops in this ratio during the Covid-19 crash in early 2020, and during a late 2018 pullback.The good news is that the S&P 500 Index (SPX) bottomed along this ratio during those pullbacks, and the current ratio appears to have stopped falling.
What's Driving the Ratio?
For gauging sentiment, it’s important to know if the ratio is being driven by a decrease in call buying, or an increase in put buying. The chart below shows the 20-day BTO calls and puts. While the number of puts bought to open has meandered higher in the past couple of years, the ratio has been driven by the call volume that spiked during the recovery from the Covid-19 crash, and then again in late 2021. However, the ratio has now fallen to its lowest level since May 2020.
The steep drop in calls with no significant change in put buying seems like a bullish sign for contrarians. It suggests call buyers have lost their appetite, and if good news hits the market (regarding the war in Ukraine, for example), then those traders might scramble back into the market and push it higher.
That's akin to what happened at the bottom of the Covid-19 crash. There was a spike in call buying in the first part of 2020, but when when the pandemic hit, the call buying collapsed while put buying was steady.
Keep Tabs on These Sectors
Finally, let’s look at what option buyers are doing within specific sectors. I have grouped stocks into just over 40 sectors. The table below lists the 20 sectors that have the most BTO volume over the past 20 days. For each of the sectors, I show the percentage of volume it makes up, along with the BTO call/put ratio on Nov. 15 (the recent peak) for that sector and current ratio. I then divide the current ratio by the past ratio to arrive at the last column.
The technology hardware sector accounts for 15% of BTO option volume, which makes it the most liquid sector. At the height of the call-buying spree last November, the call/put ratio for this sector was 3.23, which was higher than the overall market. The current ratio is 1.51 which is below the current value for all stocks.
The ratio of these numbers is 0.47. Since it’s lower than the ratio for all equities (0.62), it means the decline has been more severe for the sector. Only the “open end investment vehicles” has a lower ratio.
There are two sectors in which call buyers are now more prevalent than put buyers, compared November: banks and precious metals. For whatever reason, call buying collapsed relative to put buying for stocks overall, but these two sectors saw the opposite reaction.
If the market bottoms here and rallies for the reasons mentioned above, then the contrarian take would be that these two sectors are likely to lag the overall market.
