Last week the VIX traded at the lowest level since November, but the VIX:VXV ratio dropped to 0.78. Readings below 0.80 are extremely rare.

The VIX reflects anticipated volatility over the 30 days. The VXV reflects anticipated volatility over the next three months.

The expectation of increased mid-term volatility (VXV) relative to short-term volatility (VIX) is usually a contrarian indicator.

In other words, when investors expect short-term volatility to remain subdued, the market delivers the opposite.

The chart below plots the S&P 500 against the VIX:VXV ratio. As the dotted blue lines show, low VIX:VXV ratio levels tend to spell trouble for stocks.

View VIX chart

The only unusual development is that the CBOE Equity put/call ratio is relatively elevated. A rising CBOE Equity put/call ratio tends to coincide with lows.

What do we make of all this?

The S&P 500 reached an obvious resistance zone last week. The VIX:VXV ratio suggests lower prices. It makes sense to expect further weakness. The elevated put/call ratio may soften the effect of the VIX signal or cause any pullback to become more choppy.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013, 17.59% in 2014, and 24.52% in 2015.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

I Spy … Put/Call Ratio Soaring to Highest Level since October

Option traders are acting irrational.

On March 30, the CBOE equity put/call ratio fell to the lowest level of 2015.

Just three days later (April 2), the put/call ratio soared to the highest level since October 2014.

In fact, the chart shows a near perfect ‘V’ with all three touch points representing some sort of extreme.

Sunday night’s Profit Radar Report published a similar chart and noted that: “The equity put/call ratio just spiked to the highest level since last October. Option traders are expecting lower prices. As the chart shows, usually when that’s the case, the S&P 500 does the opposite.”

The S&P 500 cash index (NYSEArca: SPY) doesn’t fully reflect the volatility since Friday’s job report, but the S&P 500 futures spiked from their 2,043 low on Sunday to 2,075 today.

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The S&P 500 may or may not be done punishing bearish option traders, but the volatility of the put/call ratio cautions that it may not take too much of a rally to work off last week’s bearish (bullish for stocks) put/call extreme.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013 and 17.59% in 2014.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

VIX Put/Call Ratio Drops to 6-Year Low – Does This Foreshadow Single-Digit VIX?

Option traders are flocking towards call options, as the put/call ratio has dropped to 0.1. This means that there are 10 call options traded for every put option. A contrarian interpretation of this data points to even lower VIX readings, but this is not a contrarian indicator.

Another day, another extreme.

The VIX put/call ratio dropped to 0.1 yesterday, which means that there are 10x more call options traded than put options.

The 10-day SMA of the VIX put/call ratio fell to 0.273, the lowest reading since July 21, 2008.

A contrarians initial impulse (most sentiment indicators carry a contrarian message) would be to expect even lower VIX readings.

However, a look at similar historic setups suggests that the ‘herd’ (call buyers) may actually end up being right.

The chart below plots the VIX against the VIX put/call ratio. The S&P 500 is also included for additional insight.

The red lines highlight similar extremes.

A similar put/call ratio extreme in January led to a 50% VIX spike. Most other occurrences were followed by a VIX rally within the next couple of weeks.

The only outlier is the March 2007 extreme, which was followed by a declining VIX and rising S&P 500 (NYSEArca: SPY).

VIX Seasonality

The VIX’s descent towards its 88-month low (thus far at 10.34) harmonizes with VIX seasonality. Back on March 21, when traders started looking for a VIX low, the Profit Radar Report published a VIX seasonality chart and stated that: “VIX seasonality is not yet supportive of higher readings.”

VIX seasonality has not yet bottomed, but it’s getting close, enhancing the meaning of the low put/call ratio.

This article includes a link to the only free and updated VIX seasonality chart on the web and answers the question if it’s finally time to buy the VIX:

VIX Hits Another 88-Month Low – Is it Finally Time to Buy?

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

Equity Put/Call Ratio at 41-Month Low, but Risk of ‘Black Swan’ Event Limited

Last week the CBOE Equity Put/Call ratio slipped as low as 0.43, the lowest level since January 2011. Similar readings in April 2010 and April 2012 led to nasty sell offs? But something is different this time.

Last week the CBOE Equity Put/Call ratio plunged to 0.43, the lowest reading since January 2011. This wasn’t just a one-day fluke as the 5-day SMA fell as low as 0.518, also a 41-month extreme.

A ratio of 0.43 means that option traders bought 2.3 calls (bullish option bet) for every put (bearish option bet). Option traders don’t have a ‘smart money’ reputation.

The chart below, featured in the June 11 Profit Radar Report, plots the S&P 500 (SNP: ^GSPC) against the 5-and 10-day SMA of CBOE Equity Put/Call ratio.

As the dashed red lines highlight, low put/call ratio levels led to S&P 500 (NYSEArca: SPY) weakness more often than not.

Is the Put/Call Ratio Warning of a Crash?

Lately, there’s been much talk about a crash or major correction. Does the current equity put/call ratio foreshadow such a crash or correction?

Looking at the put/call ratio in isolation one could conclude that there’s a high chance of a 1%+ correction. Why?

Similar equity put/call ratio readings in April 2010 and April 2012 were followed by nasty sell offs (see red shadows).

But let’s expand our analysis to include the CBOE SKEW Index. The SKEW Index basically estimates the probability of a large decline (2 standard deviations or ‘Black Swan’ event).

Readings of 135+ suggest a 12% chance of a large decline. Readings of 115 or less suggest a 6% chance of a large decline. In short, the higher the SKEW, the greater the risk for stocks.

Last week the SKEW finished at 127.78, which is above average, but well below its January peak of 139.62.

The April 2010 and April 2012 highs saw SKEW readings of 134 and 139 (shaded areas).

The relative SKEW anemia softens the generally bearish message of the put/call ratio, but it doesn’t eliminate all the risk.

The Profit Radar Report’s 2014 S&P 500 Forecast (published on January 15), projected a pre-summer high at S&P 1,950. Last week the S&P reached 1,950 and pulled back. What does this mean for the rest of the year?

A complimentary look at the updated 2014 S&P 500 Forecast is available here:

Updated 2014 S&P 500 Forecast

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

A Detailed Look at 5 Different Sentiment Gauges

If you want to know how much money is waiting on the sidelines to drive stocks higher, take a look at various sentiment measures. Combine those sentiment measures with actual money flow gauges and you’ll get a good idea of how much cash is left (or not) waiting to buoy the stock market.

Seasoned investors look at many indicators before making buy/sell decisions. One of them should be sentiment.

My personal ‘three pillars of market forecasting’ are technical analysis, seasonality, and sentiment.

Technical analysis includes trend lines, patterns (like triangle, head-and shoulders, etc.), Fibonacci levels, divergences and so on.

Seasonality includes seasonal patterns and cycles for broad indexes and sometimes individual stocks and sectors.

Sentiment can be subdivided into many segments. I consistently follow more than a dozen sentiment and money flow gauges and regularly chart the following five for Profit Radar Report subscribers:

CBOE Volatility Index (VIX)
CBOE Skew Index
CBOE Equity Put/Call Ratio
% of bullish advisors polled by Investors Intelligence (II)
% of bullish investors polled by the American Association for Individual Investors (AAII)

The chart below is a reprint of the July 25 Sentiment Picture (available to subscribers of the Profit Radar Report).

It plots the S&P 500  against the above-mentioned sentiment gauges.

The VIX (NYSEArca: VXX) continues to linger near a multi-year low. This has been the case for almost a year. Using the VIX to time market highs has been a fool’s errand. We realized that back in November 2012 when the Sentiment Picture ‘quarantined’ the VIX:

“When an indicator doesn’t work, we’ll put it on ‘probation’ until it proves its worth again.” Let’s just say the VIX has continued to be on probabation.

The put/call ratio is a valuable member of the sentiment family. The May 19 Sentiment Picture noted that option traders were finally jumping on the rally bandwagon and warned that: “Risk is rising. A fair portion of current gains should be quickly retraced.” The S&P 500 (NYSEArca: SPY) quickly lost 7% thereafter before rebounding.

Sentiment polls by Investors Intelligence (II) and the American Association of Individual Investors (AAII) are a ‘casualty’ of the QE liquidity market and need to be taken with a grain of salt.

Extreme bullishness reflected in the polls hasn’t had much of an impact on stocks, but bearish extremes have coincided with rallies.

The April 26 Sentiment Picture for example picked up on the extremely bearish AAII poll numbers and the large number of II folks looking for a correction and wrote:

“36% of advisors and newsletter writers polled by Investor’s Intelligence (II) are looking for a correction. Incidentally, that’s exactly what we are expecting. However, the market rarely fulfills the expectation of the masses.” In other words: expect higher prices.

It took years of trial and error to become familiar with the various sentiment gauges and learn how to interpret the different readings. I have found that there’s a difference between sentiment polls and money flow indicators. The equity put/call ratio, for example, is an indicator that shows if investers are really ‘putting their money where their mouth (sentiment polls) is.’

When the put/call ratio finally reached extreme territory in May (and investors started to put their money where their mouth is), the stock market turned sour, at least temporarily. A updated chart and analysis of the equity put/call ratio is available here: “Is a Market Top Near? ‘Smart’ Option Traders Send a Curious Message.

Continuous sentiment analysis is available via the Profit Radar Report.

Investors Now Embrace the Most Hated Stock Rally Ever – Is it Time to Bet on Short ETFs?

After a 12% rally investors are starting to buy into the S&P 500 and other indexes again. At the same time technical resistance is getting stiffer and seasonality is turning bearish. Is it time to buck the trend and start nibbling on short/inverse ETFs?

PIMCO’s king of bond funds, Bill Gross, joined the “stocks are dead’ club in late July and CNBC calls the latest rise in stocks the “most hated stock rally in history.”

At the June 4 low (1,267 for the S&P 500) investors and investment advisors hated stocks like fish hate hooks. Despite (actually because of) this negativity stocks keep on keeping on and June 4th turned out to be the second best buying opportunity of the year (see charts below).

But nothing is as persuasive as rising prices, and 12% into the rally investors are starting to embrace the idea of continually rising stocks. The crowd is generally late to the party (thus the term “dumb money”) and this time may be no different.

Investor sentiment is an incredibly potent contrarian indicator. Unfortunately, sentiment-based signals in recent months have been murky, but are starting to make sense again.

Murky Doesn’t Have to be Bad

Murky is not always bad though. The following is what I mean by murky during this summer and how the sentiment picture is starting to clear up.

The Profit Radar Report (PRR) continually monitors various investor sentiment measures, which includes the Investors Intelligence (II) and American Association for Individual Investors (AAII) polls as well as the Equity Put/Call Ratio and VIX.

The Sentiment Picture below was published by the PRR on July 20, 2012. Quite frankly it was one of the oddest sentiment constellations I’ve ever seen. The VIX was near a 60-month low parallel to a multi-month pessimistic reading of the AAII poll.

This just didn’t make sense and the simple conclusion was that there is no high probability trading opportunity.

Six weeks and several head fakes later the S&P 500 Index (SPY) is trading a measly 30 points higher than it did on July 20, and even in hindsight we know that there was no high probability trade.

Current Sentiment Picture

The second chart reflects the change of sentiment of investment advisors (II) and retail investors (AAII) since July 20. There’s no excessive bullishness, but rising prices are starting to resonate with investors.

Sentiment alone doesn’t tell us how high stocks may rally or if they are ready to crack right now. When we expand our horizon to include seasonality and technicals we see that September (especially starting after Labor Day) sports a bearish seasonal bias and that there’s strong resistance at S&P 1,425 – 1,440.

There is little reason for investors to own stocks right now. Aggressive investors may choose to pick up some short or even leveraged short ETFs at higher prices.

The Short S&P 500 ProShares (SH) and UltraShort S&P 500 ProShares (SDS) are two inverse ETF options that increase in value when the S&P slumps.

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