Tuesday, December 13, 2011

Put to Call Ratio calling a top

The Put to Call Ratio is defined as the ratio of trading volume of puts options to call options. This indicator is one among many readings that gauge the overall sentiment of the market. A high reading indicates that the number of investors are buying put options speculating that the market will move lower. Readings of 1 or higher mark important bottoms in the market where buyers of puts at these levels are said to be the "dumb money". The "Dumb Money" is the retail investor that experiences panic selling and sharp volume declines to finally feel convinced to buy puts. It is at this time that the market has reached capitulation and deeply oversold levels creating bargain opportunities.
Remember, this is a contrarian indicator that can be used to reveal short-term tops and bottoms of the market. In the chart above I have removed the raw data and inserted the 10 day moving average to smooth out its inverse correlation to the SPX daily index chart. Bottoms in the blue line are marked as short-term tops in the market. The latest data shows that a short term top has been produced in the SPX index.

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