The Put/Call Ratio Charts

In the Dumb Money Trader Facebook Group today, I posted this pic with the comment “I look at put/call ratios from time to time. In specific, $PCSP and $PCALL. Noticed that both bottomed today. Bottomed where they’ve been hitting bottom for quite some time. These charts sometimes coincide with what the market does – the same seesaw effect. Meaning, if PC hit bottom, the market may pullback soon.

Somebody replied to it basically asking what I meant, and what is the PC ratio telling me. And his question was my inspiration for this blog post. So here we go!

First, the only 2 PC charts I use are 1) $PCSP (put/call ratio for the S&P 500) and 2) $PCALL (put/call ratio for the entire market). There are others, but I will not get in to them right now.

The P/C ratio chart (I call them PC’s) is the ratio between puts and calls. Remember from options 101 that puts are bearish, and calls are bullish. To know what the ratio is you simply divide all the puts by all the calls.

Let’s say there are 1000 puts and 500 calls. The put/call ratio would be 2 (1000 puts divided by 500 calls). Now let’s say there are 500 puts and 1000 calls. The put/call ratio would now be .5 (500 puts divided by 1000 calls). Lastly, let’s say there are 1000 puts, and 1000 calls. The put/call ratio would be 1 (1000 puts divided by 1000 calls).

So now that you know the basic math involved, let’s discuss the basic theory behind this ratio.

According to Investopedia, a ratio above .7 is considered bearish, and below .7 is considered bullish. That is, above .7 means there are more people buying puts than buying calls. Which can be a bearish sign. Why .7? Simple. Since people typically buy more calls than puts, using a ratio of 1 would not be “accurate” to determine market direction because that would imply a 1 to 1 split between puts and calls. So, the investing gods decided .7 was a good “middle” point. Honestly, past what I just told you, I don’t know any other reason for .7 being “neutral.”

Now, what can this ratio tell us? I use these charts from time to time, to help me determine which direction I think the market is going. If I open this chart and see a rising PC, I may go easy on my bullish bets. But if I open this chart and see a falling PC, I may increase my bullish bets. I have noticed that this ratio sometimes coincides well with market moves. Meaning, I have noticed that some very bearish days in the market was preceded by a rise in the PC ratio.

If people are getting bearish, they’re not going to buy calls, and vice versa if people are getting bullish. So, if the PC is rising, that can be a sign that people may be getting more bearish because they are buying more puts. If the PC is falling, that can be a sign that people are getting more bullish because they are buying more calls. As always, does this mean it’s guaranteed bearish or bullish sign? Absolutely NOT! But the more tools you utilize to make investing decisions, the better off you might be. No one particular “indicator” is going to be 100 % accurate.

Investing is like a puzzle – You have to put all the pieces together to see the bigger picture.

OPTION GREEKS – DELTA

Delta is my personal favorite “Greek” when looking for options. I would bet that it’s other traders favorite as well… and for good reason! It is how much you will make (or lose) for a 1 point gain (or loss) in the underlying.

Here is a screenshot from my TD Ameritrade account option chain. This chain is for SPY – the S&P 500 ETF I trade frequently.

The yellow highlighted rectangle is showing you the call delta’s for any given strike price. This particular chain is for October 25, 2019 expiration. So, what do those numbers mean? I’ll tell you…

Let’s use the 295 strike price. I have highlighted the option in question above.

This strike price, for this call option, on this particular expiration date (October 25,2019) has a delta of .51. This tells you that for every $1 SPY moves up, or down, you will gain or lose .51 cents PER CONTRACT. Don’t forget: 1 contract is 100 shares of the underlying. So, for every 1 contract, you would gain or lose $51. Let’s do the math…

Let’s say SPY moves up $1, and I own 1 contract of this call option. To calculate how much the price of my contract will move up, I simply take 100 shares (for the 1 contract I own), and multiply it by the delta which is .51… the answer equals 51, or $51 dollars. It means, if I bought the contract for $5, it would now be worth $5.51. All other “things” being equal of course.

Of course, if SPY fell $1, I would have lost $51 on my option price. I would be in the hole $51. The equation to determine that $51 is the same, but the direction the option price moved is different.

Delta is the price in which the option price will fluctuate for every $1 (1 point) move of the underlying. In this case, the underlying is SPY. Notice, the delta is less and less the farther “out of the money” the option is. It gets closer and closer to an even 1 for 1 the farther “in the money” the option is. Right “at the money,” like this option I hypothetically bought, the delta will be around .50. But delta is ALWAYS between 0 and 1.

Keep in mind,there are other Greeks in options (theta, vega, gamma) that influence the price of an option. But all else remaining equal, delta is simply the price fluctuation of the underlying based on a 1 point move (up or down) of the underlying.

SPY KEEPS ON TRUCKIN’

On my Trading View account (JayC81 if you wanna look me up there), I just published this chart. Notice, I started my spiel off with “Unbelievable!” Know why? Because it is…

As I have said quite a few times recently, the technicals and fundamentals are mounting in favor of the bears. Yet, through it all, the market keeps moving up… like a freight train – you just can’t stop it.

So, my question is this: should we, as traders/investors, care if it goes up or down? I ask, because I have been focusing on when to short the market, while missing opportunities to long the market. In doing so, I have missed out on some pretty good gains. Any good trader can make money when markets move up, the same as they can when markets move down.

My point is this: don’t be shy! Always keep your eyes open for good opportunities. It’s always about the opportunity, more so than the direction… in my opinion. I am now playing the market both directions. That is the game it wants to play, so that’s the game I’ll bring.

I always say – LEARN TO PLAY THE GAME! If you can’t beat em’, join em’!

SPY Taking a Breather

Yesterday, SPY gapped up and made a doji to close out the day. Today, that doji was followed by a bearish engulfing candle. By itself, a doji usually means reversal. The bearish engulfing candlestick that followed the doji, in my mind, is confirmation of a reversal.

I am bullish the US markets. But I think they are in for a pull back … more so, a profit taking round.

After breaking through the consolidation that lasted about a month (the green dashed line), SPY has been on a rip. This week it made new highs, but failed to close above the all-time high set in July of 302.23. I think this is a point where investors may want to take some profits.

Technically

See the long up-trend line I drew? That started from the low of last year on 12/26/2018. Up until July 26 that line held very well … then all hell broke loose, and SPY plummeted to 281.72. It then entered a period of consolidation that lasted until September 5, when SPY finally broke out of it with a pin bar gap. Fast forward a little more than a week, and here we sit at the all-time highs again.

But, notice how after we bounced off 281.72 it tried to get back above that long-term trend line and just couldn’t do it? And then tried a couple more times but failed … Then finally on the 5th of this month it busted through with conviction. That’s why I’m bullish overall from a technical standpoint.

However, I believe we are going to see some profit taking before the Fed speaks next Wednesday 9/18/2019. I think the doji yesterday, and the bearish engulfing today, shows that we are going to pull back from this level. Not too mention, profit taking is not uncommon at all-time highs. I think the pullback takes us to around 295 area (green dashed line). From there, fundamentals will determine if we bounce off and retest the all-time highs … or more ominous … continue down through the green line and confirm a double top pattern.

Fundamentally

TRADE WAR!!! Need I say more? It’s all about the US/China trade war. Jerome Powell and the Fed have nothing on the trade war. The market wants an end to it, and they want it now. Unfortunately for us (the market), it’s not going to happen now … well, I don’t think so anyways.

The reason SPY broke through the consolidation was because the US and China agreed to continue talks in October – the markets went berserk on the good news! But I remained skeptical; do you know why? Because when did the US/China talks ever stop? They’ve been going on for a year and a half. You gotta use logic here, but the markets don’t like logic. They like the news.

Logic tells me that nothing has changed on the trade war front. The talks have never truly “stopped” and this is nothing more than another round of them. October will go one of two ways: 1) A deal is made or 2) A deal is not made. That’s it! Don’t expect anything else. Well, the many other rounds of talks had the same two options.

When there’s talk of negations, the markets move up. When the talk turns to negative (i.e. nothing happened in the talks), the markets move down. That’s the pattern we are in, and that’s the pattern I believe we will stay in until a trade deal is made.

Donald Trump wants to get re-elected, so I think a trade deal will be made before then. But the elections are more than a year away; that’s a long time for this thing to be drawn out.

Bringing it all together

I think technically SPY is very bullish. I think fundamentally SPY is at the mercy of the trade war. Bringing those two together, I am basically trading on the news rallies or declines.

Disclaimer

ALWAYS DO YOUR OWN RESEARCH BEFORE MAKING ANY INVESTMENT DECISION. SEEK PROFESSIONAL GUIDANCE IF YOU ARE UNSURE.