Could Put/Call Ratio Fuel Oversold Bounce?

My friend Ari Wald sent over a great chart yesterday showing some extreme readings coming out of the Put/Call ratio. This technical indicator measures investor sentiment by calculating the ratio between all put options and all call options purchased on a given day. A lower reading below 0.6 generally represents complacency among investors, while readings above 1.0 show that fear is in the market and can historically be taken as a bullish signal.

Ari does a nice job smoothing the ratio by using a 10-day average to clean out some of the noise. The chart is also inverted to better show bullish & bearish signals. He had this today regarding the data:

"Pessimistic Put/Call data indicates dry powder for a bounce: From a trading perspective it has become incrementally bullish that previously ebullient sentiment has receded over the course of the last month. Specifically, the 10‐day composite Put/Call ratio is above 1.0 from mid‐May readings near 0.7. Such stretched positioning indicates that there is dry powder to support a continuation of the S&P 500’s bounce from its 50‐day m.a. should investors react favorably to potentially dovish Fed comments. Any such bounce faces resistance at 1687, and, in our view, would likely be part of a multi‐month period of consolidation"

Last time we hit such extreme levels of pessimism in the ratio was last summer, which sparked a 16% rally in S&Ps over the next 3 months. The time before that was in the Fall of 2011. The market rallied 30% over the next 5 months. Will history repeat?

Make sure you're following Ari on Stocktwits & Twitter @AriWald

Source:

Princeridge Technical Strategy (June 18, 2013)

Tags: $SPY $SPX