wmeubank@ocp.kcmo.com
THE OPTION ADVISOR
Prepared by
Investment Research Institute, Inc.
As keen observers of sentiment among option traders and the Street as a whole, we have been concerned by signs of investor complacency over the past two months. While the technical picture has moved from uptrending to sideways in the short term (as the Dow has to date experienced a 9.4% correction from high to low before bouncing to retest the 8000 level in the past week), option speculators have clearly shown little worry about this correction. Equity put/call ratios have been hovering around 2½ to 3 calls trading for every put, whereas we prefer to see less than 2 calls trading for every put near market lows. The CBOE Volatility Index (VIX) this week saw three straight closes below its lower Bollinger Band, meaning that we were seeing extremely little fear in the face of the flirtation with the key Dow 8000 area.
The last time the VIX experienced this much complacency occurred after the three straight closes ending July 2, 1996. The pain over the subsequent month was memorable, though it led to a longer-term buying opportunity. We expect a similar scenario for the stock market here, as we would like to see a much higher fear level than we have seen thus far in this correction. The ideal similarity to the market lows of July 1996 and April 1997 would be a pullback to the 200-day moving average, currently nearing Dow 7300. Perhaps such a brief but sharp decline would spark renewed fear in those buying on the 10% correction scenario around Dow 7600.
Another concern we have is the character of this correction relative to past corrections within the bull market. In bull markets, declines are often sharp but short-lived and rallies are slow and steady, as investors fear a top and rush quickly out of stocks before buying again emerges. In bear markets, the opposite is true, as rallies are sharp and force much quick short covering before the bears again take control. In the past six weeks, we've seen three sharp rallies that were reversed with steadier declines, capped by the memorable 247-point rally in the Dow on September 2. We're also seeing a sharp reversal in the spin being put on the recent negative earnings pre-announcements. In past years, such negative news was greeted as a harbinger of worse things to come, while now the spin is that if a company hasn't had a negative earnings pre-announcement, it's probably due for a positive surprise. All of this tells us that the odds of a negative surprise in the short term have increased, though certainly all bets could be off if the Dow surges meaningfully though the 8000 mark, or if some other signs of pessimism reappear. We expect renewed fear on a more dramatic decline back to long-term support, after which our sentiment-based approach would again point to a more clear-cut buying opportunity with the long-term uptrend.
September 26, 1997 Price Headley, Director of Research
Investment Research Institute, Inc.
1259 Kemper Meadow Drive, Suite 100, Cincinnati, Ohio
Consensus National Futures and
Financial On Line Index
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