By Chris Ebert
Beginning today, the graphs for each of the 3 option indices have been expanded to show past performance going back a full 2 years. The change was made in an effort to allow traders a more comprehensive view of how each index can be used to detect the emotions of traders in a wider variety of market conditions. These indices are provided no only as an aid to option traders seeking the best strategy for a particular type of market, but also for stock traders as additional technical indicators that can be used to predict future trends.
Option Index Summary
The Covered Call/Naked Put Index (CCNPI) indicates an increase in bullishness this week, while the Long Call/Married Put Index (LCMPI) continues to indicate a lack of bullish strength. The Long Straddle/Strangle Index (LSSI) remains normal. The most important change in the indices this week was in the CCNPI, which is now fairly close to a level that is often indicative of long-term uptrends, but not quite there yet.
Covered Call/Naked Put Index (CCNPI) – Bullish
Profitability of at-the-money covered calls and naked puts generally indicates bullish sentiment among traders. That was again the case this week, as those trades opened 7 days, 28 days, and 112 days prior to today’s expiration all returned profits. But a chart of the CCNPI reveals that sustained bull markets are often accompanied by a specific pattern that is not currently present.
When the 112-day CCNPI is near +5%, the 28-day at +2%, and the 7-day at +1%, the chart takes on a green-yellow-red appearance that has a high correlation with uptrends in the S&P 500, and these uptrends tend to continue without any major correction until the green-yellow-red pattern ends.
Long Call/Married Put Index (LCMPI) – Weak
At-the-money long calls and married puts opened 112 days prior to expiration continue to be losing trades, indicating that the recent bullish trend remains weak. However, the LCMPI often trails the CCNPI, and often indicates strength only after a bull market has been underway for several weeks. Weakness in the LCMPI can also sometimes be a warning sign of an impending selloff, even when the market is rallying, as was the case in July of 2011.
Long Straddle/Strangle Index (LSSI) – Normal
The LSSI remained normal this week, suggesting that the emotions of traders are currently justified. When the LSSI is normal, attention to any trends in the CCNPI and LCMPI is warranted. This week, the trend in the CCNPI is towards more bullish sentiment than in recent weeks, but it has not yet returned to the green-yellow-red pattern which would signal a long term uptrend in the S&P.
All Index values are calculated relative to the S&P 500 using volatility data to extrapolate the theoretical performance over the given time periods. It is not possible to match the exact performances shown because the strike prices and expiration dates available in actual trading will always differ from those used in the calculations.
The preceding is a post by Christopher Ebert, who uses his engineering background to mix and match options as a means of preserving portfolio wealth while outpacing inflation. He studies options daily, trades options almost exclusively, and enjoys sharing his experiences. He recently co-published the book “Show Me Your Options”.
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