Sentiment Watchers Get Mixed Message From Options Market

No one likes mixed messages, mixed signals, or confusion. Unfortunately, that's exactly what some sentiment indicators in the options market are giving off, amid another lousy day in the stock market.

Volatility Index
Today	% Change
40.98	+12.61
Source: ILX

The market's fear gauge, the Chicago Board Options Exchange Volatility Index, or VIX, was soaring, indicating a palpable sense of anxiety among investors and traders, while another measure, the CBOE equity put/call ratio , is suggesting that some traders don't think it's that bad.

Nasdaq Volatility Index
Today	% Change
71.90	+0.78
Source: ILX

The VIX, which measures the implied volatility of certain S&P 100 options, and is known as the market's fear gauge, soared to an intraday high of 41.44 today, a level not seen since April 2000. That means, essentially, traders are willing to pay more money for OEX put options to protect themselves from any further market weakness.

Some investors interpret the VIX using contrarian theory, meaning that low readings on the VIX are bearish, while high readings are bullish. Implied volatility is a key component of an option's price and the market's estimate of how much the underlying security can move.

Sharp spikes in the VIX have helped signal short-term turning points in the market in the past. They have also helped signal major bottoms in the market in past years because of extreme readings in the index. The most extreme reading occurred in October 1987, when the VIX surged as high as 172.79. Yes, 172.79. That level makes the high readings in October 1997 (55.48) and October 1998 (60.63) look like nothing. However, those sharp spikes in 1997 and 1998 helped indicate that the market was ready to turn around and rally after a steep decline.

The VIX, however, isn't as popular as it once was, because it is based on OEX index options, a listing on which volume has waned, and because tech stocks have taken a larger share of the market. It is, however, still watched in many corners of the trading community.

Last April 14's intraday VIX peak of 41.531 signaled at least a modest short-term rally in the market. From an intraday low of 723.32 on April 14, the market rallied until April 26, when it closed at 789.07, a rise of 9%.

In the face of the spike in the VIX, however, investors didn't seem concerned enough to buy a lot of put options on individual stocks.

The equity put/call should be at 1.00, said Jay Shartsis, option strategist at R.F. Lafferty in New York, yet at midday Thursday, the CBOE equity put/call ratio is only at 0.53.

Traders also use the equity put/call ratio as a contrarian indicator. Contrarians look at the ratio and when readings become extremely high, that is bullish, because it signals that perhaps a downturn in the market is about to reverse itself, because everyone is panicking and buying put options. A reading of 0.53 is hardly reflective of panic.

Some traders speculated that perhaps the market is not going to see the traditional capitulation that marks a classic market bottom, but instead it might be a matter of the market continuing to churn lower and lower.

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The Options Clearing Corporation today said it has been selected by the Options Linkage Authority to provide a system by which the CBOE, the American Stock Exchange, the Pacific Exchange, the Philadelphia Stock Exchange and the International Securities Exchange would be able to link their markets.

The OLA is a joint authority of the five options exchanges and was created to structure a linkage between the exchanges that will provide direct access from each market to competing markets, designed to execute customer orders at the best price available.

In October 1999, the SEC ordered the exchanges to develop a linkage plan. In July, the SEC approved a linkage plan put forth by the CBOE, Amex, and the ISE. An alternative linkage plan proposed by the PHLX and the P-Coast was rejected by the commission. The PHLX and P-Coast subsequently joined the Amex-CBOE-ISE linkage plan.

Since the advent of multiple listings of options in 1999, the options market has been fragmented, with many options trading on as many as five different exchanges, frequently at different prices.

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