Do You Love It Or Do You Love It????? – The Dow and S&P Rally Off Early Lows to Bounce 15 and 5

November 28, 2006 at 2:44 pm  ·  Category: Options, Sentiment Analysis

After yesterday’s huge sell-off I wrote:

What say I?  DON’T PANIC.  Jim Cramer always likes to say: “Nobody ever made a dime by panicking”.  In fact, this is the time to have trust in your reasoned convictions and double down.  That’s right, you heard me: buy more Jan07 SPY 137 calls at $3.50. 

You have to learn to love this kind of market volatility.  When the market has big moves like this people’s emotions get the best of them and you have the opportunity to sell or short overheated stocks and buy those that were the victim of panic selling.

With the bid/ask on the Jan07 $137 calls at $3.70/$3.80 those of you who took my advice are already up more than 7%.  Not bad.

People ask me: how do you know people are pessimistic about this rally?  If the market is going up doesn’t that mean people are buying and so they are optimistic?  Not necesarily.

One of my favorite sentiment indicators is the put/call ratio.  You take the total number of outstanding puts and divide it by the total number of outstanding calls. 

What can this tell us about people’s sentiment towards the S&P 500?  Let’s look at the volume and open interest in puts and calls for the S&P 500 ETF (SPY):

                                        Puts                                         Calls

                               Volume  Open Interest               Volume   Open Interest

Dec06                      52,362     1,443,933                   30,261     620,817

Jan07                      29,954        258,113                   12,493     121,842

Total                       82,316       1,702,046                  42,754     742,659 

Source: Scottrade

These numbers tell you alot.  For every call contract that was bought on the S&P 500 ETF for this month and next today there were almost two put contracts bought (1.93).  And the put/call open interest ratio for the next two months is 2.29.  That means that there are a whole lot more bears on the S&P 500 than there are bulls.  In other words, like I said, “Nobody believes this rally can continue”.  And that’s bullish because it means there’s money on the sidelines. 

In addition, money market account balances have been growing for the last 5 weeks, from $2.254 trillion on Oct 25 to $2.311 trillion as of last Tuesday Nov 21, according to the Investment Company Institute.  That’s an increase of $57 billion (2.53%) – alot of money. 

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Read more on S&P 500 (SPX), HSBC HLDG, Vantage Intl HLDGS at Wikinvest
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