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The following is a guest contribution from our friends at the PazzoMundo blog:

Funny how any given data set is open to interpretation. I’ve been following the CBOE Put to Call ratio particularly closely of late (last post here) as I have been concerned there may be a change of trend in the wind.  Vix and More made the point yesterday that the ratio is not signalling a correction.

So to the problematic data – following is a chart of the put/call ratio:


Now what I have been concerned about is that the trend down in the ratio since November 2008 looks to be under serious threat.  In that context, the ratio’s behaviour after the 2007 highs is worth considering.  Note that the mid-December 2007 sell-off in the S&P 500 came off a higher low in the ratio (the 10 day average bottomed on 6 December 2007 at 0.626 versus the prior low at 0.570 on 15 October 2007).

For a closer look at the ratio, the following splits the atom – put and call volume charted separately:


The dominant dynamic over the last 6 months has been the elevated volume of calls.  Hence, the spike in the 10 day average put/call ratio to 0.522 on 16 October 2009 was principally driven by a rapid spike in call volume.  Conversely we have not witnessed any such pick-up in put volume – the trend remains down with lower highs and lower lows.

With momentum struggling in the equities markets, I think it’s reasonable to expect call volumes to fade in sympathy.  But as a harbinger of a trend change, I’m looking for a pick-up in put volume as was the case through early 2008.  In the absence of this, agree with Vix & More that the put to call ratio is not pointing to a correction.  Just that, in my view, the absolute level of the put/call ratio is a secondary matter.  (Though, given its reliability as a leading indicator of an imminent pullback, would gladly welcome a drop in the ratio towards 0.50.)

Okay, back to dissecting chicken livers.

Source: PazzoMundo