Is It Time To Panic?

August 4, 2014 12:29 PM

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Is It Time To Panic?

Friday saw some extreme readings in sentiment, which brings the question is there enough fear out there to form a major low?

For starters, the CBOE options equity put/call ratio spiked clear up to 1.04 on Friday.  As I discussed here, this is the highest level in three years and 19th highest reading since 2003.  Remember, when everyone is trading bearish puts that could be a sign of extreme fear in the options market.  From a contrarian point of view, that could be a bullish sign.  

cboe equity put call ratio spike august 2014

The ISE Sentiment Index saw similar action, as its proprietary call/put ratio registered the second lowest reading ever!  This ratio looks at just customers opening long positions, so it is a fairly true gauge for the overall action.  Again, this ratio was very low, which suggests buying puts over calls was near historic levels.  

Now what throws a real wrench into the whole thing is there were rumors some of those trades on Friday weren’t legit and were ‘fat finger’ trades.  Reuters summed it up here, but as of now the trades appear they’ll count.  They just might need to have a big asterisk next to them.  

Regardless, the action in the VIX suggests some real fear is finally entering the marketplace and this could be a real clue for some near-term strength.

Looking at the VIX/VXV ratio we see it just moved above 1.0 - or is now officially inverted.  Now remember, the VIX looks at volatility going out one month, while the VXV goes out three months.  When things are ‘normal’ this means near-term volatility is lower than further out volatility. The reason is the longer you hold something, the more time there is for some big event to happen that could cause volatility - so you tend to pay more for this.  That makes a lot of sense if you think about it.  The flipside is when there is a good deal of panic, we see this ratio become inverted just like it did late last week.  This is much more rare.  

Going back to 2012, you can see this is now the 8th time this ratio has become inverted.  Safe to say it doesn’t happen much.  

Here’s a chart with the SPX overlaid and you’ll see a lot of previous spikes in this ratio nailed some major SPX lows.

Now check this out, here are the returns after those previous seven spikes higher.  Sure, there are only seven occurrences, so one could argue some of this is random.  Still, the near-term returns are simply outstanding and suggests paying attention here.  I’d rather know than not know.

Here are all the signals and returns after.  

Lastly, there were times this ratio became inverted and it didn’t lead to higher prices (think ‘08).  So if we are still in a bull market, I’d expect some strong prices soon.  If not, buckle your seatbelts.  

Thanks for reading.  

Picture courtesy of Kaylala Madmaydel

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