The CBOE Put/Call ratio continues to be one of the most effective short-term timing indicators for the stock market.
The CPC is a short-term, contrary indicator. It compares the action in call options to the action in put options. A reading above 1.20 shows extreme bearishness among speculators and can indicate a good time to buy stocks for the short term. A reading below 0.80 shows extreme bullishness and could indicate a good time to sell.
And, as you can see from the following chart, this indicator has been “spot-on” at signaling short-term reversals in the broad stock market…
We’ve had multiple CPC “sell signals” over the past few months – as indicated by the red arrows on the chart. In every case, the S&P 500 sold off within one or two days afterwards. Most of the pullbacks were shallow – ranging between about 20 and 50 S&P points.
That is the nature of short-term signals. But they can still produce profitable trades for nimble traders.
The most recent sell signal came in early May, just before the China trade war fears ignited last week.
Buy signals have been much less frequent this year. That’s not a surprise. The CPC indicates potential reversals in the market. And over the past few months, there haven’t been any decline phases to reverse… until last week.
The CPC closed at 1.28 on Thursday. That’s above the 1.20 level that indicates extreme pessimism. And, from a contrary perspective, that’s a buy signal.
Given this condition – and given the remarkable track record of this short-term indicator – it shouldn’t be any surprise that the stock market reversed Friday’s opening losses and closed higher the day. Traders who were watching this indicator should have been looking to buy into Friday’s decline.
The CPC is still at elevated levels – closing Friday at 1.24. That, plus the new Volatility Index (VIX) buy signal that triggered on Friday , should lead to some bullish action in the stock market early this week.
Don’t get too comfortable on the long side, though. The stock market suffered significant technical damage last week. There’s a good chance the intermediate-term trend has shifted from bullish to bearish, and that stocks will be lower several months from now than where they are today.
For the very short term, though, the CPC indicator is bullish.
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