A Fresh Look at Stock Market Psychology
My blog has recently begun
an investigation into the value of equity put and call options as sentiment
measures. I’ve developed
a different way of viewing the options data, by looking at put volume and
call volume as separate indicators. The resulting measures appear to do a nice
job of
predicting returns in the S&P 500 Index over a two-week horizon.
In my look at the options data, I am focusing on
the relative elevation of put and call activity in the market. Thus, we have a
high equity call ratio when the day’s call volume is above its own
100-day moving average. We have a high equity put ratio when the
day’s put volume is above its own 100-day moving average. By viewing calls and
puts individually, we can parcel out the impact of each upon the market.
In this investigation, I’m focusing on daily
periods in which we have *both* a high equity call ratio and a high equity put
ratio. What this is assessing is an elevation in total speculative activity
among options traders. After all, the traditional put/call ratio can be 1.0
because both puts and calls are trading low volume or because they are both
trading high volume. We lose information when we focus on the ratio rather than
the components.
It turns out that, since 2004, we’ve had 86
instances of an equity call ratio above 1.2 *and* an equity put ratio above
1.2. Twenty days later, the S&P 500 Index (SPY) was up by an average of 1.19%
(64 up, 22 down). That is quite a bullish edge relative to the remainder of the
2004-2006 sample, which showed an average 20-day gain of .54% (395 up, 239
down).
When both put and call volumes are elevated, we
have significant differences of opinions among bulls and bears. In a sense,
we can view that as a proxy measure for market uncertainty. When this
uncertainty is high, stocks appear to yield superior returns over the following
month. Combining this measure with the VIX–a measure of volatility priced into
options–might provide an interesting options-based view of stock market
psychology.
Brett N. Steenbarger, Ph.D. is
Associate Clinical Professor of Psychiatry and Behavioral Sciences at SUNY
Upstate Medical University in Syracuse, NY and author of
The Psychology of Trading (Wiley, 2003). As Director of Trader
Development for Kingstree Trading, LLC in Chicago, he has mentored numerous
professional traders and coordinated a training program for traders. An active
trader of the stock indexes, Brett utilizes statistically-based pattern
recognition for intraday trading. Brett does not offer commercial services to
traders, but maintains an archive of articles and a trading blog at
www.brettsteenbarger.com and a
blog of market analytics at
www.traderfeed.blogspot.com. His book,
Enhancing Trader Performance, was recently released for
publication (Wiley).