The risk of an equities correction: Larry Berman
The number of calls bought relative to puts has rarely been higher.
The put-call ratio offers a good reading on shorter-term speculation. The standard is a one-week average perspective to smooth out the day-to-day noise. We also look at a one month perspective, where we are seeing even stronger readings. It often takes weeks of extreme positioning to create key market inflection points.
When investors are bullish and want to use leverage, calls allow for speculation on the upside with limited losses. When bearish, buying puts helps protect downside risks to portfolios. The degree of speculation in November is in the top percentile when compared to the past 25 years.
History suggests that the market is at risk for a correction. The indicator does not tell us when, how long it might last, or how deep it might go. The last strong reading we saw like this was in early September and markets corrected 10 per cent. In the past, other corrections were more muted. We typically want to pair this type of indicator with what we are seeing in the speculative and hedging positioning markets like futures. The net speculative position in the NASDAQ and S&P 500 are not confirming this for now. From this perspective, we are probably okay for a few more weeks, but the set up is building for a poor first quarter at this point. The Dec. 21 index rebalancing and the Dec. 16 FOMC are both catalysts for speculation on stimulus and position flows.
Look for more in the coming weeks from our new Berman’s Call Probable Return On Investment Index, PRO-II (pronounce Pro Eyes) Indicator. We will be launching the new website in early January so that BNN Bloomberg viewers can follow along with the various risk and opportunity factors we follow.
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