Ask TheStreet: Contrarian Cues

CBOE Volatility Index

For contrarian and lay-trader purposes, the Chicago Board Options Exchange Volatility Index, or VIX, is most usefully referred to as the market's "fear gauge."

Technically speaking, however, the VIX is a measure of the level of implied price volatility of the S&P 100.

RealMoney.com options guru Steve Smith explains the predictive nature of the VIX: "The underlying theory is that, at any given moment in time, the majority opinion is wrong. A rising stock market is viewed as less risky than a declining stock market. The higher the perceived risk is in stocks, the greater the demand for protective options, driving up prices and sending implied volatility higher. Hence, if everyone is in a panic, selling stocks and buying puts, the bottom might be at hand."

Smith notes that as a contrary indicator, the VIX is more reliable for defining market bottoms, expressed in extreme "fear," or high volatility, than for flagging tops based on "complacency," or low volatility.

The VIX currently stands at a somewhat complacent 12.6, although it has jumped to its highest level in a month. VIX readings above 45 have marked major market bottoms and ensuing rallies in the past.

CBOE Put-to-Call Ratio

The name of this indicator refers to the two main options classes, those that become valuable when the underlying stocks fall (puts) and rise (calls). The put-to-call ratio is simply the volume of all puts divided by the volume of all calls that trade on a particular day. Like the VIX, the put-to-call ratio runs in direct proportion to investors' nerves: The higher the number, the shakier their knees.

A reading over 1.0 indicates bearishness in the market, because a high level of put-buying indicates a rising level of fear. That bearishness, of course, is bullish if you're a contrarian betting against sentiment.