SMART MONEY CONSENSUS (Positive Consensus/Bear Market Indicator): Bearish positions highest in 16 years

March 9, 2015

A lot of our observations of Consensus are very contrarian based. In other words when a constituency of experts and prognosticators tend to take a firm position on a certain market event, more times than not, it becomes more profitable to take the other side of that call. In rare cases there are indicators that can challenge that paradigm. One such indicator is tracking a certain group of traders that commiserate around indexes such as the S&P 100 options pit (aka the OEX). They have often been called the “Smart Money” for having the knack to see out into the future. It is important to differentiate this group from other groups that I have personally deemed as Smart Money People which I classify as professional portfolio managers, soothsayers, and market strategists who have degrees stacked a mile high and are often the go-to people for commentary by the business media because they can articulate a good game. There’s a difference.

So what is the Smart Money doing right now? Well it appears they are betting on stocks going down like no one’s business. Currently the open interest level ratio (i.e. active option positions) is at 2:1 for put options to call options. This means there are twice as many put options active (betting stocks will go down) than call options (betting stocks will go up). Based on this, bearish sentiment is at its highest level in almost 16 years.

Historically, it has been rare to see twice as much open interest in OEX Puts as Calls. From 1998 through 2013, there were a total of 7 days that saw that Put/Call ratio above 2. In 2014, more readings began to pop up. From July through the end of the year, there were 8 total readings above 2. The past several days have seen that trend accelerate even further. Consider the following:”

  • Each of the past 6 days have seen the Put/Call Ratio of OEX open interest > 2.
  • The 4 highest readings of the past 15 years all occurred within the past 6 days.
  • The 5-day moving average of the Put/Call ratio reached > 2 for the first time in the last 16 years.
  • Based on past occurrences from 1999 to 2015, whenever the Put/Call crossed 2, the subsequent 1week to 6 month period saw falling stock prices.

So is the Smart Money right? The data shows something is percolating out there. The wildcard that is holding it back is when and if the Federal Reserve in the US decides to normalize rates from their historical lows. This catalyst will provide juice to the Smart Money behaviour, but no one really knows when that will happen. So until rates start going up, the potential is there for the Smart Money to lag in the short term.