Put Call Ratio for Options Trading

Topic: The Put/Call Ratio

Folks: This letter addresses a fundamental subject in option analysis - sentiment readings. Please read it carefully and write me if you need help in understanding it. A good grasp of the Put/Call Ratio is very important to your trading.

Dear Options Trading FAQ:

I have an options trading query for you to consider. Let me introduce it by copying to you a portion of a recent news article by a Reuters reporter, Medora Lee who often writes about options trading. She is writing of Bernard Schaeffer's bearish outlook on the tech sector due to the high number of calls being chased:

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Despite expected gains in broader U.S. stock indices and the Dow 30, Schaeffer warned that technology indices continued to look bearish. "I remain bearish on the semiconductor sector although bounces are certainly possible after the recent huge declines," Schaeffer said, adding, "both Applied Materials (AMAT) and Micron Technology (MU) continue to attract hordes of bottom-fishing call option speculators, and there is very muted put activity. This is classic bullish sentiment in a bear market that strongly suggests that the bottom is not at hand."
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Now, it seems to me that this comment on call option activity is not very insightful. At some point the market *will* turn around and at that point those that have been fortunate enough to predict it and time it will be correct in their bottom-fishing call speculation.

I'm personally not big on trying to time the market since I don't think it can be done, but to claim the bottom fishers are wrong because they are a reverse or contrarian indicator also seems problematic. But maybe there are some things I don't know about using put/call ratios as technical indicators of market direction.

Can you enlighten? Thanks again for your continued commentary on options trading.

Options Trader Confused by the Put/Call

Dear Put/Call Ratio Doubter:

Ah, the famous Put/Call Ratio. This is that demon contrarian indicator that *puts* (ha, ha, -very punny!) options traders into a tizzy. Option traders just can't stand being used as a wrong way signal! For those of you who need a review, it is the number of put option contracts traded divided by the number of call option contracts. In the abovementioned example, Mr. Schaeffer's eye was caught by the very low put/call ratio in the tech sector (very few puts traded as compared to calls). He reads this in the usual contrarian fashion - that the option trades represent dumb money. That is, speculative funds that usually prove to be ill invested. Therefore, he is situating himself opposite the call buyers and maintaining his bearish stance on techs.

Yes, use of the Put/Call Ratio can be problematic in that one must always take into account what the general market atmosphere is. Note that Schaeffer places the call option buying into context by referencing the bearish tech environment. This is important in that the Put/Call Ratio figures can go to different levels in different market scenarios in order to trigger a signal.

Had the same call buying occurred in a rising or flat market for AMAT and MU, Schaeffer's signals may not have been triggered. Proper use of the Put/Call Ratio comes with experience in watching it and in understanding just when certain amounts of put or call volume is allowed to increase or decrease without tripping an alarm. For instance, if MU was going straight up (instead of declining), one must allow for increased call volume caused by that rise and not go short against the natural increase in call buying.

You mention that in some cases, the market will turn and prove the fortunate bottom-fishers right. Yes, but I think you will agree that those folks were mostly just lucky guessers. That money does happen to represent purely speculative money as opposed to really smart money. By and by, one must use the Put/Call Ratio as a contrary indicator. There are exceptional times when other rules apply (I'll cover that subject in an upcoming letter), but stick with the classic interpretation as a general rule.

Bottom line for options traders? I think Mr. Schaeffer's analysis is sound and was reported well by the news service. Whether he'll turn out to be right in his market judgment is another matter. Only time will tell.

Keep an eye out for advanced Put/Call Ration interpretation techniques in future letters.

Good Luck!

PS. I have been working on my own proprietary option sentiment survey which I'll unveil in the very near future. I'll be collecting market opinion surveys from the Options Trading FAQ readership and compiling the data for distribution to the major media channels. The standard Wall Street sentiment studies (AAII, Consensus, Market Vane, Investor's Intelligence, etc.) have been getting a bit stale in their polling methods. It's time for a little shakeup!

The Options Trading FAQ Sentiment Survey (TM) will be the first electronic weekly sentiment polling of a very interesting demographic group. The average Options Trader FAQ reader is a well educated, solidly financed, internet savvy, private investor intensely interested in advanced trading techniques. Such a group certainly deserves to be tracked. Using the technology of the Internet to do so will allow for accurate and timely data gathering. I am very excited about this venture and hope the readership will be kind enough to contribute to this leading edge research project. Warning! As with the other sentiment surveys, we may find ourselves also to be a reliable contrary indicator. In that case, we'll just always place our orders opposite to our market opinion. It's certainly been working for myself since I started reversing my orders !!

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Indicators, Options Put/Call Ratio

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use. Think about your options.

Trading Options at the Opening

Topic: Trading Options at the Opening

Dear Options Trading FAQ:

I've heard that an order has to be placed by a set time before the market opens to be entitled to the opening price of a particular option. Does it mean that if you put in an a market order before the market opens, you are guaranteed a fill at the opening price?

Isn't it risky to put in an market order before even knowing the bid and ask for that option? I've found that most options don't have a bid and ask price in the first 15 minutes after the stock markets have opened. Why?

What are the trading hours for options? While you're at it, maybe you can give me a tip or two on the different ways to place an order, like at market; at bid; at ask; or in between.

Early Bird Options Trader

Dear Early Bird Gets the Options Premium:

In order to get the printed opening price, your market order must be represented in the opening rotation. Get your order down to the floor at least 15 minutes before the market opening. In busy market times, they may start the rotation procedure even earlier than that. What exactly happens during the rotation?

The individual exchanges can send you specific information, but it usually goes something like this: Starting with certain months and strikes, each option series in sequence is "opened" and a bid-ask is determined. Pre-rotation orders are filled according to this price and further trading is not permitted until all series have gone through the rotation.

As you point out, options can take 10 - 15 minutes to get through with the rotation and start trading. Here are a few implications of the opening procedure:
Playing a news-induced, gap opening? Be careful of the delay in the option trading. By the time the options start, the stock may be correcting from its first thrust already.

Use the opening to get out of your position. Pent up demand for the option can mean good news for the seller. Often the high price of the day is set at the opening. Take advantage of the swell in liquidity to offset positions at the opening.

Does that mean that those playing the opening are always wrong? I wouldn't go that far, but with news related price pushes, they seem to pay too much on that first morning's opening. This is particularly true on Mondays.

As for how to place an order for the opening, that's quite tricky. You are looking to jump on an emerging trend, but don't want to overspend either. If you are reluctant to use a market order, try an "or better" order. Let's say you wake up to the following scenario tomorrow: The S&P December contract is up 1.95, the long Bond futures up 20 ticks, and the OTC tech stocks all indicating higher. The OEX call option you've been watching closed at 2. You don't know what to do.

The market is poised to go to new highs and this could be the impetus to a great one day upmove. On the other hand, the calls will be so rich that any stalling or an early pullback will mean a drubbing to the call holders. Compromise by giving an order to buy the calls at 2 1/2 or better. That way, you have in mind a top price you will pay, but will also be entitled to the opening price if it is lower.

As for the trading hours of options, the answer depends on if it is an equity option or an index option. Equities go until 4:10 New York time (10 minutes longer than common stock) while index options trade until 4:15 p.m.
I'll discuss getting the most out of different types of orders in an upcoming issue.

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Pricing, Options Order, Market Opening

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use. Think about your options.

Stops on Options Orders

Options Trading Topic: No Stops on the SOX?(Semiconductor Index)

Dear Options Trading FAQ:

My broker wouldn't accept my stop order on the SOX. Says the specialist firm stopped taking them. Can this be true? No stops on these options?

Can't Stop Trading Options Now

Dear Options Stop Dropped:

Yes, as of last Thursday, Nov 16, the SOX specialist firm of Susquehanna Investment Group stopped dealing with stop orders on options. They applied for, and received, the ok from the officials at the Philadelphia exchange to cancel all existing option order stops and to refuse future stop orders until further notice.

Traditionally, stop orders on options are refused by the specialist in times of great volatility. In this case, it seems that recent price action by heavy-weights in the index such as Micron (MU), Texas Instruments (TXN), LSI Logic (LSI), and Applied Materials (AMAT) has caused the Semiconductor Index to swing wildly. It becomes just too risky for the specialist to try to fill the stops on his book.

Option floor sources say that such short term halts of accepting stops is not that uncommon, but is usually in effect for just a day or two. In this case, the feeling on the floor seems to indicate that this may become a lengthy affair.

It would be interesting to speak to the Susquehanna folks to see what the official party line is and when they expect to bring the stops back.

Oh, well. I guess you'll just have to stay glued to your own quote monitor all day long and watch for those options trades.

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Broker, Options Order

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use.