Market Internals: The technical action of the market remains constructive. Midday Friday, the Dow Jones Industrial Average ($INDU) was up for a third consecutive trading session and had added nearly 300 points on the week. Trading was less inspiring Monday and Tuesday, with advancers trailing decliners and down volume outpacing up volume by modest margins. However, total volume was light and the selling never gathered any real momentum. By Wednesday, the bulls were back in charge and, during the next two days, advancers trounced decliners by a three-to-one margin. Up volume outpaced down volume five-to-one.   

Sentiment Indicators: Overall, not much really changed during the past seven days and a lot of this week’s Sentiment Journal is a recap of last week’s installment. In concluding the previous installment, I explained that, “The key to watch for next week is how the market reacts to bad news and sell-off attempts. If it can hold steady and overcome weakness Monday and/or Tuesday, it will offer more evidence that the tone of the market is improving and that December is shaping up to be a better month for the bulls.” That conclusion was drawn from the fact that, “sentiment is shifting after a period of extreme bearishness” and “the technical action of the market is improving” consequently, “this pattern can feed on itself and lead to further gains for the equity market in the weeks and months ahead.”

Indeed, the market did remain resilient early in the week and the past three days have seen an ongoing decline in risk perceptions. For example, the CBOE Volatility Index ($VIX) fell Wednesday through Friday and was near 20.5 towards the end of the week. The market’s “fear gauge” is now well below its November 26 close of 28.91. Midday Thursday, the VIX fell below 20 for the first time since November 1.

Meanwhile, the ratio of puts to calls traded across the US options exchanges has been falling. During the month of November, the ratio averaged .96. So far in December, that figure has declined to .88. Figure 1 shows the ten-day average of the total put to call ratio. It is coming down from extreme levels. The fact that the decline in the put-to-call ratio is occurring amid a decline the VIX suggests that investors are leaning less heavily on the put or bearish side of the trade. The Volatility index tracks the expected volatility for the S&P 500 currently being conveyed by S&P 500 Index ($SPX) options.

Figure 1: Total Put-to-call Ratio (10-day Average)

The fact that risk perceptions are falling is important because it comes after a period of extreme bearishness. We mentioned some of the indicators that reached extremes last month. “On November 12, the CBOE Volatility Index hit a four-year closing high of 31.09. On November 8, more than 12 million put options traded across the six US options exchanges—the second highest put volume on record. The ISE Sentiment Index [ISEE], which tracks call volume divided by put volume on the International Securities Exchange [ISE], hit an extreme low of 68 on November 16, which represents its fourth lowest value of the year.” From a contrary view of the markets, the high levels of bearishness and pessimism helped form the foundation for a market bottom and that trend can continue in the near future as stocks continue to move up the wall of worry.

 

Frederic Ruffy
Senior Writer & Index Strategist
Optionetics.com ~ Your Options Education Site
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