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November 11, 2005 |
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If you had to pick one word that best describes the action in the markets this year it would have to be boring. For example, the intra-year trading range of the S&P 500 has been only 109 points, and the largest intra-day trading range has been a mere 25.21 points (Oct 19). Back when the bear was roaring in 2002 the S&P 500 traded above a 25 point trading range on 58 different occasions (or 23% of the time) – and that was then the S&P trading below an average of 1,000 versus 1,200 today. As you would suspect as stocks rebounded in 2003 the put/call ratio trended lower. However, this trend proved temporary as over the last 2-years the put/call ratio has started trending higher even as stock prices rallied. This divergence is not easily explained. While Occam’s Razor says that the naive herd is buying puts from the smart money, this theory doesn’t explain why the so called ‘smart money’ has suddenly started making one way bets. Astute options players have a history of being equal opportunists – willing to implement premium/beta based options strategies based upon sound analysis regardless of market directionality. But in 2005 – which is likely to end as the most bearish year ever for the p/c ratio average – these strategies have apparently morphed into one: save the markets during sell offs by aggressively selling put options (Schaeffers refers to this phenomenon as ‘structural put support’). Put Writers To Write History In 1999 at the height of the bull the put/call ratio only closed above 1 on a single occasion. In other words, times were so good in 1999 that market participants only purchased more put options than call options 1 time in 252 sessions. By contrast, at the height of the bear (2002) the put/call ratio closed above 1 a remarkable 22 times (or 8.7% of the time). Keeping these numbers in mind, prepare to baffled: In 2005, with the markets going nowhere, the put/call ratio has already closed at 1 or higher 51-times! Conclusions Not surprisingly, Cramer – who for all of his follies has nonetheless been in tune with this year’s boring markets – called the October bottom to the day (after the better than expected Beige Book). Also not surprisingly, the put option bullies did likewise: since October 19 volatility has dissipated, the S&P 500 has rebounded to its pre-October trading levels, and the p/c ratio has moved steadily lower. Of course, arguing that the put option bullies have found themselves their own private printing press at the expense of bears is speculation. We do not have the required data to ascertain the intentions/plans of the parties playing the 2005 put writing game, nor do we know for sure that put buyers are an unhedged clan of bears praying for a financial market meltdown. All we do know is that if you have lots of money and you aggressively write enough put options during a downturn, the markets stop dropping. Just as you have to wonder how far the commercials will go to keep the price of gold from surging, you have to wonder how far the put bullies will go to keep stocks from plunging. However, with the possibility of a serious market decline ebbing in the near term, it may be awhile before any serious wonderment can be had. After averaging 15 and 1.00 respectively in October, yesterday the VIX closed at 11.9 and the p/c ratio settled at 0.78. Worthless put options in 2005 have given many bears nightmares while exalting somebody or something the status of ‘genius’...at least temporarily. |