Equity Put/Call Ratio Suggests Down Day

One blog I enjoy reading is Cobra’s Market View. He shows a lot of charts and often does a good job finding where there is unusual action. On Thursday night he noted the CBOE Equity Put/Call Ratio had come in extremely low. I decided to do a study on performance following extremely low 1-day readings.

When looking at put/call ratios I always normalize them with a long-term moving average. To understand why you may review this post from June of 2008. For today’s study I normalized using the 200-day moving average. The Equity P/C Ratio today came in at 0.55, which is a little over 25% below the 200ma of 0.74. I then looked at all other times the Equity P/C came in more than 25% below its 200ma.

(click to enlarge – created with Tradestation)

As you can see in the above table, while there seem to be negative implications from such readings, they only last 1 day. Now let’s take a deeper look at those 48 trades and see what the results looked like over time. (Chart from Tradestation.) Click to enlarge.)

From 2004 until near the end of 2007 there wasn’t much of an edge provided. From November 2007 – present though there has been a strong bearish tendency. Seeing this graph would make many people wonder whether the negative performance is primarily just a byproduct of a horrible bear market.

There’s no way to answer this for sure. One thing we can do though is to see what performance has looked like since the March bottom. All qualifying trades are listed below:

(created with Tradesttion.)

Even during the furious rally of the last 3 months low readings in the Equity P/C Ratio have been followed by strongly negative action. This leads me to conclude that the CBOE Equity P/C Ratio may provide a short-term edge and its suggesting downside for Friday’s trading. I’d recommend checking out Cobra’s Market View for several interesting charts and observations on a daily basis.

P.S. – Would you like to be notified every time the above setup occurred? The Quantifinder can do it. Let the Quantifinder search through my blog and Subscriber Letters and alert you to studies relevant to current market action. Available with all Gold and Silver subscriptions.