By Chris Ebert
Option Index Summary
The option indices are currently indicating the presence of a strengthening bull market. The Covered Call/Naked Put Index (CCNPI) reveals a slight increase in bullish emotions this week, while the Long Call/Married Put Index (LCMPI) shows that trader's bullish convictions are likely still weak, but are beginning to strengthen. The Long Straddle/Strangle Index (LSSI) remained in overly-fearful territory again this week, which is an indication that the current market has surprised many traders who were expecting a much larger move over the past few months than what actually occurred.
Covered Call/Naked Put Index (CCNPI) - Bullish
Because sellers of at-the-money covered calls or naked puts receive a premium from the buyer, either of these trades will result in a profit as long as the underlying price does not fall by a greater amount than the premium received. Generally, when covered calls or naked puts are profitable trades, it is an indication of a bull market. Likewise, when there is a bull market, it is often profitable to sell covered calls or naked puts.
The 112-day CCNPI remained positive this week and continued to improve, and therefore is an indication of bullish emotions among traders.
Long Call/Married Put Index (LCMPI) - Weak, but improving
Because buyers of at-the-money long calls or married puts must pay a premium, these trades will only result in profits in a strong bull market. Likewise, only when there is a strong bull market is it profitable to buy calls or married puts.
The 112-day LCMPI, although negative for several weeks now, is beginning to show signs of improvement, indicating that trader's confidence in their bullishness is also weak but improving.
Long Straddle/Strangle Index (LSSI) - Overly Fearful
Because buyers of straddles or strangles must pay two premiums, these trades will only result in a profit when the market moves up or down very strongly. When a long straddle or strangle returns a substantial profit it is an indication that traders were taken by surprise - they were complacent and underestimated the magnitude the market would move. Likewise, when the market is complacent, it can be profitable to buy a straddle or strangle (although whether complacency can be observed by means other than hindsight is debatable).
When a long straddle or strangle results is a substantial loss, it is also an indication that traders were taken by surprise - they were overly-fearful and those fears were subsequently proven to be unjustified by the market's failure to move.
The 112-day LSSI remained overly-fearful this week, indicating that those who opened a long straddle or strangle 112 days ago may still be waiting for the other shoe to drop, although it is possible that it will fail to drop anytime soon. Such a failure would require those traders to accept that their fears from a few months ago were unjustified.
Option position returns are extrapolated from historical data that, while reliable, cannot be guaranteed accurate. It is not possible to match the exact performances shown, because the strike prices and expiration dates used in the calculations will not always be available in actual trading. All data is relative to the S&P 500 index.
The preceding is a post by Christopher Ebert, who uses his engineering background to mix and match options as a means of preserving portfolio wealth while outpacing inflation. He studies options daily, trades options almost exclusively, and enjoys sharing his experiences. He recently co-published the book "Show Me Your Options".
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