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February 17, 2007

Options
by Jay DeVincentis

Bi-Weekly Stock Barometer No. 152
2/17/2007 9:53:11 AM

Dear Subscriber,

Here is how to view various options activity in determining the market's next move.

Welcome to the biweekly stock barometer. This article comes out every 2 weeks and gives our big picture view of the market. If you're interested in following our signals and learning more about our system, then I invite you to click here and subscribe to the daily service - since the market can turn on a dime and so too can our interpretation as the market gives its daily clues to the future. Or sign up for our free weekly newsletter, where we provide up to date articles from our various trading services. We're also going to be releasing a free trading video in 2007 - so sign up today.

Options are a financial derivative, meaning they are a derived from some other investment option. There are so many types of index and stock options and variables concerning those options that I'm not going to get into here. I've written at length how to interpret stock option activity at various price levels. What I'm going to get into here is using options to predict future market movement.

I closely monitor the put/call ratios from the sum of all option products, Index Options, Equity Options, Options volume, QQQQ, SPX & SPY Options, Vix Options and open interest and OEX options and Open Interest and the equity to index option volume ratio.

When I say I closely monitor these instruments - that means that I personally enter this information into my indicator spreadsheets. As an old schooler, I like to enter the information by hand so I can get a feel for any data that's out of the ordinary.

The put/call ratios are said to be a contrarian indicator. Meaning when the activity is bearish, your outlook should shift to bullish. However, not all options activity is the same. Some options are used as hedges by large institutions or hedge funds. Accordingly, that data will be skewed to act more in line with the market - as opposed to against it.

The best example of this is the Qs. In the old days, pre-Jan 2005, the Qs used to be considered part of the CBOEs Equity Put Call Ratio. However, through much complaining on my part (well, at least I like to think I played a part) they moved the Qs to the Index component. Since then, we've seen much higher put call ratios that we have in the past.

(note the scaling on this chart is inverse, so higher numbers are lower)

The Index Put call ratio is really not worth looking at - since big companies use index options as a hedge, they show no correlation.

The best indicator - and what we focus on is the equity put/call ratio. This is a good indicator because more and more average joe investors trade equity options looking for the big score. The average joes are more likely to be swayed by the emotions of the market - i.e. buying calls at tops and buying puts at bottoms.

Here's a look at SPX and SPY Options:

The real interesting indicator is the OEX Open Interest Put/Call Ratio. This keeps track of the writers of options and their opinions on the future of the market.

The most interesting action occurs at extremes. And currently, the OEX writers are so bullish that the market is likely to be at a top.

That's it for our view on options this week - we'll continue on with our normal bi-weekly charts below.

Message From The Markets

Market action is ruled by sentiment and by monitoring market internals and studying sentiment; you can gain reasonably predict future market movements. The basis of the Stock Barometer system is overlaying extremes in sentiment with sound technical analysis to predict the likelihood of future price movement. Each indicator and chart measures the hope, fear and greed of investors and traders from different angles. Follow along with my charts and over time, you'll also learn to understand how to read the markets, which is essential prior to setting up each and every trade.

STOCK BAROMETER CHART

The Daily Stock Barometer is a proprietary measure of market energy. The direction of the stock barometer determines our short-term outlook on the market's direction. A BUY or SELL signal is triggered when the indicator clearly changes direction. If the line is moving up, we are in BUY MODE and if it's moving down, we are in SELL MODE. The black line is a 5-day moving average that we use to confirm changes in direction.

EQUITY PUT CALL RATIO CHART

***Chart above

The CBOE put/call ratio is comprised of two sets of data; equity options and index options. The index component contains items that are used as a hedge, thereby distorting the correlation and interpretation of the indicator. I use the equity put/call ratio. This is one of the most accurate read of investor's fear and complacency.

TRIN/ARMS CHART

Richard Arms developed the arms index. It is also referred to the Trading Index or TRIN for short. It is a measure of the ratio of up stocks and down stocks divided by the ratio of up volume and down volume. Our Spread Chart converts the arms index data into momentum Buy and Sell Signals.

TICK CHART

The tick index is represents the sum of all stocks ticking higher minus all stocks ticking lower (a stock is said to be trading on an up tick when it trades at a higher price than the last sale). It's utilized as a day trading tool as it gives you an up to the second read of the intensity of buying and selling.

BREADTH (ADVANCE - DECLINE) CHART

Each day several thousand stocks either advance, decline or remain unchanged. The number of advances and declines normally ranges from +2500 to -2500. A high number of advancing stocks normally marks a top just as a high number of declining stocks normally marks a bottom. Monitoring the 5 and 13-day moving averages of this allows us to better predict future prices.

VXO CHART

The VIX is a measure of volatility on options pricing. We use the old VIX, which is now called the VXO. The higher the volatility, the more likely the market is close to a bottom, as traders are willing to pay more premium for puts, which act as Insurance on their long positions.

Cycle Time

Monday will be day 22 in our DOWN Cycle. The Qs have been in a rather large consolidation.

The Stock Barometer signals tend to follow a 5, 8 and 13 and sometimes 21 day Fibonacci cycle that balance with 'normal' market cycles. Knowing where you are in the current market cycle is important in deciding how long you expect to maintain a position.

Potential Cycle Reversal Dates

2007 Potential Reversal Dates: 1/10, 1/14, 1/27, 1/31, 2/3. We publish these dates up to 2 months in advance.

Here's a chart of previous and future dates - we'll be watching these closely as they influence the speed of our system signals.

My timing work is based on numerous cycles and has resulted in the above potential reversal dates. They're predictive and have nothing to do with the barometer cycle times. However, due to their accuracy in the past, I post the dates here.

2006 potential reversal dates: 1/16, 1/30, 2/25, 3/19, 4/8, 5/8, 5/19, 6/6(20), 7/24, 8/20, 8/29, 9/15, 10/11, 11/28.

2005 Potential reversal dates based on 'other' cycle work were 12/27/04, 1/25/05, 2/16, 3/4, 3/14, 3/29, 4/5, 4/19, 5/2, 6/3, 6/10, 7/13, 7/28, 8/12, 8/30-31, 9/22, 10/4, 11/15, 11/20, 12/16.

Stock Barometer Buy And Sell Signals

QQQQ or SPY Chart: A chart is provided in every bi-weekly report and shows the barometer Buy and Sell Signals (which are provided in my morning updates) as well as showing the next highlighted 'reversal' window. The numbers adjacent to the buy and sell signals are the number of days between signal (cycle time).

Here's one years of our end-of-day buy and sell signals for the Stock Barometer over the past year. They're marked on the QQQQ chart with red and blue lines (or red and blue arrows). Note we recently changed bottom and top to read buy and sell.

The following work is based on my price based spread/momentum indicators for the USD$, XAU, GLD and TLT. They are tuned to deliver signals in line with the Stock Barometer. Combined with up/down indicators and you have a powerful tool for pinpointing market reversals.

Gold (GLD:AMEX & INDEX:XAU.X)

I monitor Gold in the form of GLD and the XAU as well as the US Dollar Index as a general guide to the overall health of the US Economy and the markets, as well as to assist us in the entry of positions in our Gold Stock Service.

Bonds (Amex:TLT)

I include bonds in our studies and use Lehman's 20 year ETF, as the direction of bonds can have an inverse impact on the stock market. Normally, as bonds go down, stocks will go up and as bonds go up, stocks will go down.

Summary & Outlook

We remain in Sell Resistance Mode looking for the market to move lower into 3/10. We use Resistance and Support Modes to reflect price chart action in the barometer.

Of note is the high level of bearishness on the equity put call ratio. This suggests that the sell off may occur at higher levels from here. However, since Friday was Options Expiration - a non emotional event (skewing sentiment analysis) we'll wait to see how this number resolves over the next week.

Again, if you're new to the biweekly stock barometer, welcome. This article comes out every 2 weeks and gives a big picture view of the market and our recent activities. If you're interested in following our signals and learning more about our system, then I invite you to click here and subscribe to the daily service - since the market can turn on a dime and so to can our interpretation as the market gives its daily clues to the future. Or sign up for our free weekly newsletter, where we provide up to date articles from our various trading services. We're also going to be releasing a free trading video in 2007 - so sign up today.

As always, if you have any questions or comments, feel free to email me here at jay@stockbarometer.com.

Regards,

Jay DeVincentis
Dynamic Trading

Trading involves high risk. Past results are not indicative of future returns. Stockbarometer.com and all individuals affiliated with Stockbarometer.com assume no responsibilities for your trading and investment results.

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