What Are Options Saying About the Market?

06/04/2014 12:01 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

MoneyShow's Jim Jubak delves into the recent option data to explain what it is telling him about the current state of the market.

Traders and investors watch options to see what the market is thinking about the future and in particular, one indicator is calls and puts on the S&P 500 (SPX), on the index itself. If you buy a call option, you are basically buying a chance to participate in an upswing in the market. You are basically buying the right to buy these shares that may be at a higher price in the future, but you are setting the price where you buy them now, so you are betting that things are going to go up or you can buy a put, which gives you a right to sell and that is protection on the downside.

What is interesting about options on both ends right now is that they are cheap. There is not a whole lot of demand for either calls or puts that there is not a whole lot of belief that the market is going to go up, which would be why you would buy calls if you believe we are not going to be at 19, but we are going to be at 2100 on the S&P, so you would buy a call to give you a chance to participate in that and leverage that increase. If you felt the market was going to go down, you would buy a put. Now these options do not come without cost, so what you really do if you want to try to figure out where people's bets are is you look to see what the price of calls and puts are. Right now, interestingly enough, both are kind of cheap. What that really means is there is not a whole lot of conviction that the market is going to move one way or another. You could call that complacency, but it is also I think an indication that people are saying, “Well, there is really not much catalyst to move it one way or another, I do not see the point of paying insurance to buy a put and protect myself on the downside. I do not see a whole lot of downside in the near term cards. On the other hand, I am not very enthusiastic about the market going forward, so I am not going to buy a call,” so, both these things are really, really cheap and that is really where the market stands right now, which I think is a pretty good reflection of exactly where we are as May goes into June and we try to figure out what might drive this market higher or indeed cause a sell off and it hard to see anything on the near-term horizon that moves it big one way or another.

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