S&P returns could underwhelm following the recent low in this put/call ratio
One of the investor sentiment indicators we track internally here at Schaeffer's is the 10-day moving average of the equity-only, buy-to-open put/call volume ratio. This metric reflects all customer-driven, buyer-initiated option volume across three major options exchanges -- the International Securities Exchange (ISE), Cboe Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) -- and as such, provides a broad overview as to whether traders are actively accumulating bearish bets or bullish on individual stocks.
Note that this equity-only put/call ratio is different from the exchange-traded fund (ETF)-based ratio discussed previously in this space. Whereas we've generally deduced that the ETF put/call ratio is generally reflective of hedging activity by investors -- i.e., put accumulation tends to increase on these broad-based funds as traders simultaneously accumulate shares of stock -- the equity-based counterpart tends to be fairly straightforward: It rises when investors are bearish, and falls when they're bullish. While the shift from a high (bearish) reading to a low (bullish) one can be supportive of stocks, the opposite is often true -- when the ratio rebounds from low levels, it's often a headwind for the market.
As such, it certainly caught our attention last week when the 10-day equity-only put/call volume ratio cratered to 0.477 -- its lowest reading in over a year (since June 22, 2018, to be exact). Significantly, the previous year-to-date low in this ratio was set on April 29, just one day ahead of the S&P 500 Index (SPX) April 30 high close at 2,945.83... a near-term peak that immediately preceded a 6.8% slide in the index through its June 3 closing low.
This latest shift to a bullish extreme in the 10-day equity-only put/call ratio occurred unusually quickly, too, given that it reached as high as 0.672 back on Aug. 15. For only the 10th time since 2007, the ratio fell by 25% in the course of just 25 days. On balance, this has actually been a bullish indicator for stocks in the very short term; five days after the nine previous signals, the S&P was 1.2% higher, on average, with 78% positive returns. That compares quite favorably with the index's typical five-day return of 0.1% and 58% positive since 2007 (looking at "anytime" returns).
However, the longer-term S&P returns after these rapid-fire sentiment shifts are less encouraging. Two months after a signal, the S&P is down 1.5%, on average, with only 44% positive returns -- well shy of its average anytime performance over this time frame, which calls for a gain of 1.2% and 66% positive returns. And the underperformance persists all the way out to a year after these signals, when the index sports an average return of -0.2% (56% positive), compared to its usual 7.2% return (77% positive).
Amid turbulence last week in the overnight funding market amid the latest Fed rate cut, it's worth pointing out some of the dates on these previous "put/call ratio plunge" signals. There was one in December 2008, as the mid-financial crisis stock market wrapped up its worst year since the 1930s; one in March 2010, as the Greek debt situation was spiraling out of control; one in May 2013, around the time of the infamous post-quantitative easing "taper tantrum"; and one in June 2016, shortly ahead of the Brexit vote shocker that roiled global markets.
With macroeconomic uncertainties once again serving to drive the stock market's daily whims, this sharp plunge in the equity-only put/call ratio is high on our radar. In the weeks ahead, traders should closely monitor the S&P's progress around key support levels -- including its year-over-year breakeven range around 2,900-2,940, as well as the rising 160-day moving average, just below 2,900.
Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, September 22.