I don’t have a ton of time this morning but there’s one chart that really stuck out to me that I wanted to share, but couldn’t do it via 140 characters on Twitter. …
Many have been noting the major rise in the option put/call ratio, highlighting that it’s at the highest level since the mid-1990s. This data is getting sliced, diced and forward returns are being analyzed by very angle. With that, I wanted to share one of my favorite charts when looking at the market in periods of a down trend. While the record high put/call ratio is significant, I believe more can be gleaned by smoothing out the data and not looking at simply a one day snapshot.
The following chart looks at a spread. The first part of this spread is market breadth, which simply measures the number of stocks that are going up or going down as the stock market truly is a market of individual stocks and we want to know what those individual stocks are doing. The second part of the spread is the level of protection buying, which involves a specific measure of the put/call ratio.
When the line is falling we know there’s a greater emphasis on protection buying than buying of individual stocks. This data can be quite noisy so I’ve smoothed it out, giving us a better picture of what’s taking place within the market and looking for signs of potential mean-reversion that could move stocks higher.
You’ll notice we haven’t seen this data this low very often. In fact, the current level has only been met four times in the last 15 years. Most recently in 2011 and 2016. Something I’ve been writing a lot about in my Thrasher Analytics letter is that I don’t believe we’ll see a v-shaped recovery whenever stocks do bounce. Historically when the market has declined by this degree, some type of consolidation and retest takes place. That’s exactly what happened the last time this breadth vs. protection buying data got to its current level – the first low in 2011 that was then retested and the initial low in 2016 that was also retested.
So have stocks fallen to a low? Anyone that gives you an answer with any level of certainty is lying to you. We can’t know when stocks will bounce, but what we can do is look for opportunities of potential good risk/reward entry points once time frame, risk tolerance, etc. have been taken into account.
We are now at a point where 93% of assets have produced a negative return, the highest percent in over a hundred years. There’s been major market damage over the last few months. You may remember that volatility was contracting by a great degree back in September, acting as the first sign of trouble brewing that’s now led to a double-digit slide in equities. Breadth has been thrown out with the bath water and all eyes are on buying protection via options to a level that’s marked significant pivot points in the past, unfortunately we don’t have a very large sample size to rely on. From here I want to see how the market responds, as nothing matters unless the market confirms what the data is suggesting. At the end of the day, price is what pays.
With that let me say I wish you all a Merry Christmas and a Happy New Year. I look forward to seeing what great things 2019 has in store. Be well my friends!
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.