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Despite declining by 458 million shares last month – for the largest month-to-month percentage decline since February 2006 – NYSE short interest still sits near a record high. In other words, if you assume that the shorts have not covered en masse since last Wednesday (not an easy assumption given the sharp intraday sell off on Thursday and large rally on Friday), U.S. stocks could still be prone to terrific bouts of short covering going forward.
Incidentally, the decline in short interest in August was surprising in that it contradicted what the shorts have done during previously meltdowns. Think about it: if you entered into a massive short position in March, added to this position in May, June, and July, would you start aggressively covering during the correction in August? This is exactly what the shorts have done.
Obviously shorts sellers are not acting in unison. Moreover, there is the possibility that the data has been skewed because some shorts attempted to front-run the death of the short selling ‘tick test’ while other shorts were forced to close out positions last week to raise liquidity. Nevertheless, the data suggests that there is now a ‘cover-on-the-dip’ mentality present in the marketplace, as opposed to ‘go short for the bear’…
Put Players Sing A Familiar Song
Along with the short selling and VIX data (which has received widespread coverage), another indicator worth discussing is the p/c ratio. Since late 2003 the p/c ratio has been trending higher, suggesting either that there are lot more suckers in options-land and/or negative investor sentiment is slowly on the rise (Historically the p/c ratio has been useful in pinpointing market bottoms. The basic idea being that when the suckers show up and start loading up on put options the market is about to turn because the ‘smart money’ is collecting the juicy put premiums).
If you enlarge the above chart and throw the S&P 500 in the most notable trend in recent memory have been the sharp rise in the ratio when, or shortly after, stocks have bottomed. Last week was no different: the S&P potentially put in a near term bottom during Thursday of 1370.6 and the p/c ratio matched its highest level since March on that day.
Finally, although it is difficult to read a lot into a single day of trading, that the p/c ratio settled at 1.09 yesterday (1+ is usually bearish) could actually be a bullish sign in that the ratio declined through out the day. Granted, this may be a premature speculation as it would take another 17-46 point rally in the S&P 500 for the latest put buying frenzy to emulate previous episodes (or for the bulk of put options purchased since late July to be out of the money as S&P bottoms/rallies).
Conclusion
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