This morning on CNBC’s Squawk Box Joe Kernen was interviewing an Elliott Wave newsletter writer who in his list of reasons why the market could turn lower. One of the more interesting reasons given was that the Put Call Ratio was at 10 Year lows. At times I have followed the Put Call ratio because it can tip off extreme readings and potentially a market turn. It acts as a reverse sentiment indicator. If the ratio goes to an extreme high (more bulls) then a correction could occur. If the ratio goes to an extreme low (more bears), it means that potentially the market could be due for a rally. Sentiment indicators can be helpful but are far from full proof. The problem is that extreme readings do occur near the tops and bottoms but that extreme readings can go on for long periods of time. In other words markets can stay overbought or oversold for long periods of time. This is especially true for commodities which tend to be streaky but less so for equities which seem to have more corrections along a trend line.
The CBOE publishes 3 put call ratios: One is the total put call ratio, the second is an index put call ratio and the third is an equity put call ratio. As of yesterday April 14, 2010, the Total Put Call ratio was at 0.56, the Index Put Call ratio was at 1.11 and the Equity Put Call ratio was at 0.32. The data goes back to October 2003. Of the three ratios, the Equity Put Call ratio was at the lowest reading recorded over that time (with a range of 0.32 – 1.35), the Total Put Call Ratio had only 4 lower readings over that time (range 0.32 – 1.70), and the Index Put Call ratio was near the lower end of its range (0.24 – 3.89).
The Equity Put Call Ratio
The Equity Put Call Ratio
The Total Volume Put Call Ratio:
The Index Put Call Ratio:
So what if any conclusions can be drawn from this? The put call ratio is a useful indicator and can signal overbought or oversold readings. However, it may not necessarily mean that a change in trend is imminent (although that is possible). It may best be used as a way to gauge sentiment and to more closely observe for other signs that a change in trend or a pull back from the trend is occurring. An easy sign one to watch out for is market reaction to news. If market reaction to news changes from its current all news is good, then that in addition to the Put Call ratio near 6.5 year lows could be a harbinger for a correction.
The accounts have long exposure to the equity markets.
Authored by Tom Henderson, Strategist JBH Capital.
Disclosure: The accounts have long exposure to the markets