By Chris Ebert

Recent selloffs in the market were nearly enough to cause a change in the option indices. The LCMPI came very close to a level that would have strongly indicated the end of the 2012 Bull Market, but has not reached that level as of May 10. The LSSI remains normal and the CCNPI actually returned to bullish ground this week. Although the CCNPI is positive, the weakness in the LCMPI suggests that traders who do decide to go long at this point should be extra-vigilant with stop losses or protective puts.

  • The Long Straddle/Strangle Index (LSSI) which measures the justification of fear remains well within the normal limits of -5% to +5. The index is unchanged from a week ago and is an indication that implied volatility of at-the-money options continues to be a fairly accurate predictor of performance of the S&P 500.

In a market that is functioning with normal emotions, a long straddle or strangle is generally a losing trade. Losses exceed 5% only when fear is unjustifiably high causing the combined option premiums to far exceed the actual movement of market prices. Likewise, profits exceed 5% only when the market moves in a way that takes the majority of traders by surprise.

  • The Long Call/Married Put Index (LCMPI) which measures the strength of a bull market is barely holding in positive territory. The only period for which either strategy would have resulted in a profit is the 112-day, and even then the return was less than 1%. Earlier in the week it appeared that the LCMPI might signal the end of the 2012 Bull Market. However, a requirement for that signal was that the S&P remained below 1349 this week. While it is still possible that problems in Greece or a surprise in the PPI or Consumer Sentiment could cause a selloff on Friday that would meet that requirement, the LCMPI has not yet been tripped.

In a bull market a long call or married put will be profitable as long as the trend is strong enough to overcome the loss of value on the options due to time decay. When these trades become unprofitable, the cause is either a weakening of the uptrend, the market entering a period of consolidation, or the beginning of a bear market. When the LCMPI changes, the CCNPI is often helpful in determining the cause.

 

  • The Covered Call/Naked Put Index (CCNPI) which measures bullishness or bearishness regardless of trend returned to positive territory this week. Except for some mixed performance in April, the index has remained bullish since early December.

Writers of covered calls or naked puts only experience losses in strong downturns which are normally associated with bear markets. When the CCNPI is positive for the 112-day, 28-day, and 7-day periods, it can be inferred that the bulls are in control. It is only when panic sets in that a selloff will become significant enough that the CCNPI turns negative, often signaling the start of a bear market.

 

All Index values are calculated relative 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“.

One Response to “Option Index Update 05.10.12”

  1. Karen Starich Says:

    Great article Chris. I hope you will do a follow-up next week i would be curious if there is a change to the bullishness on the CCNPI.

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