Soaring energy prices. Japanese natural disasters and nuclear meltdowns. Libyan air strikes. European debt contagion. All were top of mind concerns for options trading investors two weeks ago when stocks stumbled in what were the deepest losses since last summer. Bearishness was rife.
Things are different now.
We’ve seen investor sentiment swing in a big way over the last two weeks — particularly in the options market. Both the CBOE Volatility Index (CBOE: VIX) and the CBOE Equity Put-to-Call Ratio have moved resolutely into big uptrend territory. Just look at the chart of the VIX, known colloquially as Wall Street’s fear gauge, which has plunged beneath its 50-day moving average as options traders are no longer scrambling for downside put option protection against stock market losses.
Similar moves below the 50-day MA in the past have marked uptrend initiations for the stock market.
Another way to look at the action of the option market is to compare the activity of equity call options versus equity put options. CBOE Equity Put-to-Call activity is declining at a pace not seen since January. This is good news since it signifies traders unwinding put option positions and bulling up with call options. It ends three months in which put option activity was dominant. Sentiment is turning positive once more.
Because of the underlying volatility in the put/call option ratio, it’s hard to illustrate clearly. I use the percentage price oscillator in the chart above to help normalize the day-to-day shifts. As you can see, we’re coming off a period of heavy put option activity — since the green bars represent uptrend activity in the put/call option ratio. And when it rises, it means that puts are more popular than calls. Over the last month, put option activity had been increasing at a pace not seen since last May’s flash crash.
All of that’s unwinding now, which should put a solid bid under stocks in the weeks to come. Admittedly, this indicator is jumpy. But the takeaway here is that options traders — which tend to be some of the most professional institutional investors out there — are getting excited about stocks again.
And finally, market breadth has recently swung into positive territory in a big way.
In fact, breadth has improved enough that a number of medium term measures have broken out of a multi-month funk. This includes the McClellan Oscillator (shown above) which is calculated based on the upward momentum of the NYSE Advance-Decline line. This is a big deal since it represents buying enthusiasm on a level that hasn’t been seen since September, the last time the McClellan Oscillator was at these levels.
Translation: More and more stocks are participating in the uptrend as buying demand surges. In fact the current rebound looks to be carrying more energy than the bounce out of the November low after the bailout of Ireland.
All of this confirms that the bulls are decidedly in charge despite a plethora of possible negative catalysts over the horizon including disappointing Q1 earnings, the end of the Fed’s $600 billion “QE2” initiative, and a possible eurozone bailout of Portugal and the spreading of contagion to Spain (which is too large for Europe’s bailout fund as it stands now). Obviously, these are worries for another day.
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