Sentiment Indicators and Contrary Opinion
positions represents a sell signal, whereas a clear downturn represents a buy sig-
nal. A simple trendline penetration is employed as a filter for directional change
in the net commercial positions. We also see the Money Flow Index based on tick
volume diverging from price at various points. The reverse bullish divergence co-
incided well with the buy signal and so did the reverse bearish divergence, with the
subsequent sell signal on the net commercial positions.(3) trading activity
In this section, we will observe how options may be used to define and track
the behavioral characteristics of market participants. We will see how the
under‐informed participants behave under adverse market conditions and we can
use this to track market bottoms and tops.put/Call ratio: using Option volume and premium This sentiment indica-
tor tracks total put volume over the total call volume, although there are a few
variations to the basic calculation that may involve the use of premium values.
Put options, or puts, are bought if the participants believe that the market is go-
ing to decline, while call options, or calls, are bought if the participants believe
that the market is going to rise. Hence if the ratio of puts to calls is rising, this
suggests that the under-informed are bearish or lacking confidence in the market.
Extremely high values indicate the potential of a market bottom being formed,
while extremely low values indicate the potential of a market top being formed. It
is more effective in signaling tops than bottoms.
In Figure 23.7 we see a 20‐day rolling linear regression slope of the CBOE Op-
tions Total Put‐Call Ratio signaling potential market bottoms whenever it tests or
crosses its historically overextended level. A 20‐day exponential moving average
(EMA) smoothes out the CBOE Options Total Put‐Call Ratio, signaling the same
market bottoms as the rolling linear regression slope.the volatility Indices: the vIX—using Implied volatility The VIX has an in-
verse relationship with the S&P 500, as seen in Figure 23.8. This sentiment indica-
tor of trading activity tracks the degree of implied volatility in the options traded
on the S&P 500. It measures the fear of participants in the markets by the amount
of options activity on the S&P 500. Normally, higher readings on the VIX signal
the formation of potential market bottoms, while lower readings point to a more
bullish scenario. In Figure 23.8, we see the large decline in the market beginning
around the end of 2008, culminating in an extreme reading on the VIX, after
which the market rose rapidly. We may use its previous extreme readings on the
VIX as a guide to potential future bottoms.
A 20‐day rolling correlation of the VIX and the S&P 500 clearly shows that,
on average, the two indices are negatively correlated. See Figure 23.9.using net Open position and pending Order analytics Some brokerages re-
port the total number of open positions and pending orders associated at each
price level. This is valuable information. The net open position shows the level of