UBS' Andy Lees: No, The Surging Put/Call Ratio Does Not Imply A Market Bottom, And May Presage A Waterfall Cascade In Stocks

Tyler Durden's picture

Yesterday when we observed the conventional wisdom explanation that since the CBOE equity put/call ratio is the highest it has been since January 2009 and hence the market must have bottomed, we naturally took the opposite stance, warning that any comparison to past events is necessarily apples to oranges, since the "last time we checked back in January 2009 Greece and Europe were not
about to go Chapter 11, nor was a $900 billion asset purchasing program
about to end." Well, we are not the only ones to ridicule yet another attempt by the media to sucker in the retail investor, who however following the biggest domestic mutual fund equity outflow since August is long gone. UBS' Andy Lees does a far more convincing job, and adds that "the skew to the downside is not reflective of
people being long puts but rather reflects the inability of funds to
carry any significant downside business risk. Putting these two bits of
information/ supposition together, clients are effectively running a
binary position where they can take the downside risk to a certain point
and then must get out no matter what which potentially means a gap down
or accelerated fall in the market, which would coincide with what the
charts are saying sub 1200. With the buyer of last resort, the Fed, no
longer there, the fall could become very nasty very quickly."   

From UBS:

Set Up For A Fall

Several people were earlier pointing to the S&P put call ratio as a reason to be bullish equities; everyone is hedged and therefore the market should go up. Let me put a different angle on it.

Without more information, the index tells us very little. Implied volatility remains relatively low, and I am told that as the market has moved down, rather than the ATM option riding the volatility curve higher, the ATM vol has remained unchanged, ie the curve has come to the option rather than the option moving to the curve. With bond yields depressed, few people have the eear-with-all to finance protection. Far more likely they will have been selling premium to try and boost returns. This matches with the depressed volatility of the market and the grind lower rather than any aggressive sell-off. It is also backed up by our own anecdotal evidence, at least up until yesterday.

It seems therefore that the put call ratio is high because of non-dynamic put sellers against dynamic put buyers. As the market has
gone down, the market makers would therefore have bought the index, dynamically matching the option deltas. The non dynamic put sellers will only hedge their position - (take profit or loss) - when the option either expires worthless or when it is deep in the money and they are forced to cut the position.This is when the potential risk comes if funds have to effectively unwind their positions. I would also suggest that the skew to the downside is not reflective of people being long puts but rather reflects the inability of funds to carry any significant downside business risk. Putting these two bits of information / supposition together, clients are effectively running a binary position where they can take the downside risk to a certain point and then must get out no matter what which potentially means a gap down or accelerated fall in the market, which would coincide with what the charts are saying sub 1200. With the buyer of last resort, the Fed, no longer there, the fall could become very nasty very quickly.