Option traders are getting that speculative urge again.

The CBOE Put/Call ratio (CPC) closed Monday at 0.73. That’s the lowest reading since mid-June – the last time traders got super bullish. That also happened to be right before the S&P 500 dived 200 points in about one week.

We warned back then the put/call ratio is an outstanding short-term contrary indicator for the broad stock market. It compares the buying interest in call options, to the buying interest in put options.

A reading above 1.20 (the blue line) shows extreme bullishness among speculators and can indicate a good time to buy stocks for the short term. A reading below 0.80 (the red line) shows extreme bearishness and could indicate a good time to sell.

This indicator has proven to be quite accurate at timing short-term reversals in the stock market. So, the extreme level of buying interest on Monday is a bearish sign.

Take a look at this chart of the CPC…

The red arrows point to extremely low readings in the ratio. All four of the previous signals were followed by immediate declines in the S&P 500 of anywhere from 70 to 400 points. The most recent signal in June knocked 200 points off the index.

So, there’s a good reason to be a little bit cautious about stocks right here. Speculators are a little too willing to bet on even more upside in the market.

They may be right for a short while. But, as the CBOE put/call ratio has proven time and again, when traders are jumping over themselves to buy call options, stocks are closer to a short-term top than a bottom.

Best regards and good trading,

Jeff Clark

Reader Mailbag

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Source: ITU Pictures