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Chart of the Day - options
The NFL season mercifully came to an end for 1/2 of the teams yesterday that are not advancing to the playoffs. My favorite team-the Bears-ended the year by finishing in dead last in the League. This is no small feat because the Bears typically linger in mediocrity & not incompetence as the last time the team came in dead last was 1947. The benefit of finishing last is the team now gets the 1st draft pick of college players in April. This is a very envious spot to be in meaning the team has options as the path it can take on a road to improvement. This doesn't mean it will be a successful path, but given the options, the fan base is ironically quite optimistic.

Options can be a very good thing. It is much the same way in the mkts. The options mkt is often decried by many investors as 'financial weapons of mass destruction' or 'dangerous use of leverage'. However, if used properly, investors can implement options in their portfolios to generate a higher risk-adjusted return for themselves or their investors. After all, options are just insurance & it is the only insurance market where we can all both buy AND sell insurance. Can't do that with auto/home/life. You can do that with your investing portfolio (I would not encourage you to do so unless you have done some studying on how to).

Because of the power of options, I like to look to the options market for clues as to investor sentiment and potential direction. Options are what investors are doing with their money whereas surveys are what people say (not always the same thing). I look at two measures from the options mkt here. First, in blue, is the Credit Suisse Fear Barometer which measures the level of investor fear in the market by pricing a 3 month zero cost collar. Leaving aside the semantics, the idea is looking to the options insurance market & measuring how much fear there is, how much demand for insurance. When there is fear, the mkt tends to do better. When there is complacency, the mkt tends to suffer. Right now, there is complacency.

The white line is a similar but different line. It looks at the put-call ratios. I use a 20 day moving avg to take out some noise. Here I look at the inverse so things line up. It is similar in that it is measure demand for puts vs. calls. It is different in that given the bulk of the options market has moved to very short-dated options, it has become much more a measure of traders than investors. Whereas the portfolio manager will look out 3, 6 or 12 months to hedge, the day traders look to use options to express short-term sentiment. The inverse of this 20 day mov avg also has predictive power and leads both the CSFB & the SPX. It is rising, meaning the inverse is lower suggesting lower stocks.

Two different measures, both pointing to lower mkts. Options can be a good thing if used properly. When we can observe what that mkt is telling us, we can be better off.

Stay Vigilant
#markets #investing #optionstrading

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