$$ Various Put-Call Ratios

Schaeffer's Investment Research provides lots of free sentiment information and charts. One of my favorites is their chart showing the 21-day average of the put-call ratio.

On any given day, the put-call ratio is simply the number of put options traded that day divided by the number of call options traded that day. The ratio falls when call trading dominates put trading. The ratio rises when put trading dominates call trading. Calls are by nature bullish, and puts are bearish.

So, when the 21-day put-call ratio average spikes to a multi-month low, it's a sign of euphoria and greed. When the the 21-day put-call ratio average spikes to a multi-month high, it's a sign of fear and pessimism.

Many traders use the put-call ratio as a contrarian indicator. When price rallies up as the put-call ratio spikes down, traders often look to sell or short the security. When price corrects down as the put-call ratio spikes up, traders often look to build a long position or cover their shorts.

Let's take a look at a couple of examples. The charts are courtesy of Schaeffer's. Here is SPY:

So we can see that the 21-day put-call ratio showed greed in early January as price rose to $114, fear in early February as price fell to $106, greed in mid-March to mid-April as price was rising to $120. Currently, we are at a 6-month high in the put-call ratio showing extreme fear during this latest price correction.

Here's the GLD chart:

Again, greed prevailed in early December as price spiked to $118. Note the fear spike in the put call ratio in early February and again in late March as price corrected to $104 and $106 respectively. These were excellent entry points to get long.

Currently, we are approaching early December greed levels in the put-call ratio as price rallies to near it's early December high. While this type of analysis is not infallible, it's probably not the best time to start building a position in gold. Better to wait for a price correction that results in a up spike in the put-call ratio.