Most Bearish Reading in History

The crowds are often wrong at extremes, but there are a few groups of traders who have a proven track record of calling market turning points. They are the "smart money." When smart money positions become extreme, everyone should pay attention.The following article will explore what one group of smart money traders are telling us now.

OEX Put/Call Ratio

Option traders who trade the OEX (S&P 100) options have an excellent track record of anticipating major pullbacks in the equity markets. We can derive their market forecast by observing the put/call ratio of OEX options. When the number of OEX put options becomes extremely large relative to the number of OEX call options, OEX traders are unusually bearish.

I am familiar with the put/call ratio, but do not follow it on a daily basis. It resurfaced on my radar screen after reading the following quote from the recent MarkeWatch article by Shawn Langolis:

“Historically, this group has been on the right side of the market more times than not when their collective options position is at an extreme,” Lyons wrote in a blog post in which he pointed out that OEX traders have never held more put options relative to call options.

“They were almost all accurate in forewarning of struggles in the stock market,” Lyons said. “In late 1999 and mid 2007, the extreme readings preceded cyclical market tops. In mid-2011, the extreme occurred prior to the sharp summer decline. And while readings in June 2003 and late 2014 did not precede major weakness, the stock market did stagnate for several months following.”

Conclusion

Trading with the smart money and against the dumb money can be a very effective technique. As a result, it pays to identify and track the positions of smart money traders. The OEX option traders have an outstanding historical track record and they have never been more bearish on the equity market.

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About Brian Johnson

I have been an investment professional for over 30 years. I worked as a fixed income portfolio manager, personally managing over $13 billion in assets for institutional clients. I was also the President of a financial consulting and software development firm, developing artificial intelligence based forecasting and risk management systems for institutional investment managers. I am now a full-time proprietary trader in options, futures, stocks, and ETFs using both algorithmic and discretionary trading strategies. In addition to my professional investment experience, I designed and taught courses in financial derivatives for both MBA and undergraduate business programs on a part-time basis for a number of years.
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