Thursday, December 13, 2007

Spikes in the Equity Put/Call Ratio: A Signal With an Impressive Track Record

Here we see the daily action since the start of 2007; the pink line is an adjusted, relative put/call ratio, and the blue line is the Dow Jones Industrial Average (cash close).
The adjusted put/call ratio is the five-day equity put-call ratio divided by the 50-day equity put-call ratio. We can see in the chart above how spikes in this adjusted ratio--occasions in which the five-day put/call ratio soars above the 50-day average--have corresponded to intermediate-term market lows.

I went back to 1998 (N = 2483 trading days) and computed the daily adjusted ratio and what happened in the Dow 20 days later. We had 188 occasions in which the adjusted put/call ratio was above 1.20 (meaning that the five-day put/call ratio exceeded the 50-day ratio by more than 20%). Twenty days later, the Dow averaged a whopping gain of 2.28% (143 up, 45 down). That is much stronger than the average 20-day gain of .39% (1346 up, 949 down) for the remainder of the sample.

I find these results impressive, as they cover a number of bull and bear market conditions. Spikes in the equity put/call ratio have been excellent signals over the past year, but have a much longer track record of success.


Equity and Index Put/Call Ratios

VIX and Put/Call Ratio