Guest Post: The Amazing Shrinking Put/Call Ratio!
Submitted by Yves Lamoureux, Macquarie Private Wealth
The amazing shrinking put/call ratio!
Have you noticed lately the behaviour of the put/call ratio? Once you read the next few lines, you will agree with us that it is a rare event.
We have tracked this interesting behaviour since 2007. It is a compression event taking place in the ratio. You will notice it from a quick glance at our chart.
The put/call ratio is usually defined between a mathematical range. The best example is provided at the left of the graph. The ratio will bounce around from the mean to +3 standard deviation on a sudden drop of the Dow Jones, taking it to under 13,000.
That would be normal behaviour. In our present circumstances, something very different is happening.
The Dow started a downward trend in 2008. Sentiment is responding in a very different manner this time. With each successive drop, negative sentiment will rise less. The red arrows provide evidence of the high that was reached. From drops in the stock market beginning in early 2008, the P/C would only get to +2 standard deviation. The phenomenon continues as the ratio gets progressively compressed.
Movements in stocks toward the fall of 2008 got to + 1 standard at best.
I find the behaviour of this ratio in 2009 extremely interesting. The market’s rally provides further reduction in the swings. The P/C ratio fluctuates in an even more dramatically lower range. You will find the drifting between -2 standard deviation and the mean.
Remember that the recent high in January 2010 reflects a higher level of comfort, circled in purple, than investors felt at the 14,000 peak established in 2007.
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