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FRED GOODMAN'S KEY INDICATORS FOR
INVESTMENT SUCCESS
OEX put/call ratio and CBOE put/call ratio are converging, and that could have profound market implications. I call my comparison of the OEX and CBOE put/call ratios the Smart Put/Call Indicator -- as background to this discussion, you can read about it in an earlier entry to Key Indicators -- click here. The chart below shows a 7-year period, plotting the S&P 500 against the difference between the CBOE 10-day average put/call ratio and the OEX 10-day average put/call ratio. The difference between the two is almost always positive, except for a week or so in July of this year. That means that the OEX traders are almost always trading more puts, relative to calls, than are the CBOE traders. The chart shows that the divergence between OEX and CBOE increases when the presumably more professionally oriented market (the OEX options) starts trading huge quantities of puts but the more amateur-oriented market (CBOE) does not. If the pros are clever, there will be spikes in the chart before the market collapses, and that in fact has been the case in most of the examples below.
To make this easier to visualize, the next chart shows the actual 10-day average ratios for both OEX and CBOE with the "oscillator" -- the difference between them -- removed.
Look first at the black arrows that are pointing down to peaks in the OEX put/call ratio. The first one was a bit early and the second one was dead wrong, but most of the others appeared very close to the top of each rally. The pink arrow on the right, in October, was also late and lingered a bit too long, but the fact that the CBOE ratio rose to meet it prevented a false sell signal from being produced. When you look at the oscillator in the first chart, you will see that only the third through the sixth arrows are represented by high points made by the oscillator -- the differences. This is the object of the oscillator -- to filter the data and emphasize only the signals that occurred at market tops. Now look at the black arrows pointing up. These call attention to periods when the oscillator in the previous chart dropped sharply. They result from the two put/call ratios converging. They converge when the pros start trading more calls and the amateurs are scared and continue to trade puts with abandon. In most cases the convergence of the two ratios marked the low point in a decline. We would have profited greatly by buying when the OEX put trading dried up and the oscillator indicated convergence. Now what about today? Note that the ratios have indeed converged, and past examples suggest that we start buying. But there is one caveat. The uptrend line that has been drawn under the CBOE reveals that there has been a sustained increase in CBOE put trading since early 2000. As a result, the convergence is even greater than it would otherwise be. There may also have been a downtrend by the OEX traders during the last year making the overall convergence even greater. Hopefully convergence means that we are about to have a major rally, but we will have to rely on the totality of indicators to rigorously define that possibility. Fred Goodman, CFP, is a fee-only Certified Financial Planner based in Los Angeles. You can send him your questions and comments via email at Fred@MarketMonograph.com. The charts and commentary represent what Fred is thinking about the market and thinking of doing for his own account and for accounts he manages. There is no guarantee that you will profit from trading as discussed herein. You may lose money and Fred assumes no responsibility for what you do or do not do with this information. 
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