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Analyzing the Put/Call Ratio

11/24/2012 6:00 am EST


Lawrence McMillan

Founder & President, McMillan Analysis Corporation

Larry McMillan explains why this is a great indicator to watch and a powerful tool for telling when to get in and out of your positions.

My guest today is Larry McMillan.  We’re talking about the put call ratio and what it’s looking like today and going through the rest of 2012. So Larry, how are people using the put call ratio these days?

Well, same as always, as a contrary indicator.  If too many people are buying puts, then everybody’s bearish and you should be thinking bullish thoughts.  It’s hard to do unless you have something to measure it by because everybody says, oh, I’m a contrarian, but when you really get right down to it, you get swayed by what you hear on TV, what you read in the papers, and that’s exactly what you shouldn’t be listening to, so if you have a measure, put call ratio of the action volume, then you can rely on a statistic and not your own emotions, which emotions aren’t good, statistics are good.

Right, always data.  Well now, as we come into the fall of 2012, what’s the put call ratio looking like?

Well, obviously people are buying a lot of calls on the stock market now.  They weren’t in the beginning of June; everyone was buying puts and we’ve gone straight up since then.  We’re not really at a top yet, but we’re getting to the point after Bernanke did QE forever this week, we’re getting to a point where your call buying is starting to dominate put buying heavily, and we’re also seeing it, like, in the euro.  Everybody thinks oh, the euro is garbage, but euro has been going up really for about a month and a half and it’s not attracted a lot of adherence, so the put call ratio and the euro has dropped lower than it was in the last two tops, so I think we’re pretty—again, hasn’t happened yet, but getting towards the top and the euro.

Do you have a hard number that you say, this is getting too much; it’s time to short?

Well, what we do is we keep a 21-day moving average, a put call ratio, and when it rolls over like this, that’s a buy signal for stocks, and when it does this, rolls back up, that’s a sell signal. So wherever that happens, so it’s a dynamic interpretation, not a fixed number, so right now the put call ratio on stocks is going down because calls make the ratio go down and same for the euro, but I mean, there’s a few other things like, say, some other commodities where you might have a lot of selling coming in and things are falling apart like sugar has been one, we say something like that, but those are the two main ones I’m looking for on the near-term horizon, and also heating oil.  Heating oil is the other way around.  I don’t know if you’ve been following—crude’s been going up.  Heating oil’s been going up crazily and there’s a massive call buying there and heavy bullish sentiment in heating oil, so at the first time that thing breaks a little, and a little is a lot of money in that thing.  First time we say we get a ten-point break in the heating and oil futures, I’ll be short.

We’re also coming into wintertime, which seasonal trade would say it’s going to increase in price still, right?

Well, I think that’s all being discounted, though, I think—we have a trade that we do in the fall of the year, for slight digression, but we spread heating oil versus unleaded gas or regular gas now, and everybody thinks oh, it’s the winner, so gas should go down and heating oil should go up, but in fact, by the end of October, beginning of November, those things start to switch around and start going the other way.  They’ve already discounted the winter, now they’re discounting the spring and that’s a good trade, but that’s not really a put call ratio trade, that’s just a seasonal trade.

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