Monday, October 08, 2007

Put Option Premiums and Short Interest Are Up Again: Smell the Fear!

Skittishness over the U.S. stock market's record-setting rally is reaching a crescendo among options traders who are preparing for a crash.

This was the lead in a Bloomberg article, entitled "US Market Stumble Presaged by S&P 500 Options", today. This little story had more than just a cryptic title wrong with it. The article pointed out that the price premium for put options are much larger than the premium for call options at the moment. Using this single data point, the article concludes that a crash is coming.

It did make me wonder. Why in the world would someone think that the crowd would be right in picking a top? I'm sure the author of this article has heard of the spike in option trades before a big move in a stock, but that is due to the fact that people usually know something and word leaks out. Typical option volumes are pretty low and it is easy to find unusually large put or call positions being opened. The reality about looking at price premium of entire markets is that they are usually used at contrarian indicators. When the crowd is fearful, you should be greedy. Go do the research yourself. When people are scrambling for put option protection, the market usually moves higher.

While I laughed at the logic (or lack thereof), the article did give me some relief, as I was worried that people were getting too bullish. I fully expect a pullback to at least the 20 day moving average, but the large short interest and high put/call ratios should once again provide some very good support for the market.

Did I mention that NYSE short interest was back at record highs? The chart below gives the put/call premium ratio and the public to specialist short ratio. The short ratio (red) is basically the "dumb money" shorts, and as you can see it is pretty high. The put/call premium ratio 5 year high was in 2003. I don't think I see a crash after that number.

In a side note, I was very disappointed by Tom O'Brien of TFNN today. He didn't mention this article in his radio show. While I know he is a bear, he should still face the reality of current market conditions. I know he read it. Shame on you Tom.

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