Options Players See Monday's Fear Feeding Tuesday's Rally

Heavy put-buying leads to a strong performance across the board.
Publish date:

Smell the fear. Love the stock market.

There aren't many panic buttons that get options traders hopping around as fast as the

Chicago Board Options Exchange's

overall put-call ratio, which closed Monday at a whopping 0.70, a level not seen since February of this year and October 1998, when it hit 0.80 and even approached parity.

More important, said Joe Sunderman of

Schaeffer Investment Research

in Cincinnati, is that Monday's 0.70 close capped a fairly tame, smoothed-out 21-day moving average of 0.38.

"It's been fairly low over the past few weeks," Sunderman said of the ratio. "So this move is definitely out of the ordinary. We take that as a bullish sign." According to the options Bible,

Options as a Strategic Investment

(Prentice Hall Trade, 1992) by Larry McMillan, the average is around 0.50. McMillan and other options gurus adhere to the wisdom that once options-buying tilts clearly in one direction, the market is about to shift.

Thus, the massive put-buying on Monday was signaling an end to the weakness because the masses are typically wrong -- or, at the very least, late. The put-call ratio is one of the cornerstones of this contrarian school of thought.

Enough mumbo-jumbo. "If events like this week's economic data and Greenspan's

remarks don't play out as expected, that could give the market a real shot in the arm," Sunderman explained. Thus, investors gear up for that possibility by buying puts.

eBaying at the Moon

An exercise in confusion: That would be an Internet company the day it releases earnings.

So you owned


(EBAY) - Get Report

August 105 calls before Monday's postclose earnings report and conference call, with the price at 10 1/4 ($1,025).

Tuesday morning those same calls were trading at 6 1/2 ($650). Meanwhile, the August 90 puts that traded Monday for 3 1/2 ($350) were worth 3 7/8 ($387.50) today. Tuesday afternoon saw the stock down 3 1/4 to 101 1/8.

Before an important earnings announcement, implied volatility often increases, juicing the price of options. In one of the most vivid manifestations of the buy-the-rumor, sell-the-fact reality of the stock market, the volatility often evaporates once the earnings are known.

Standard Bearer

About a month after some heavy


Standard Products


got a bid from

Cooper Tire & Rubber

(CTB) - Get Report

. Standard Products, a maker of auto and appliance parts, agreed to be acquired for $36.50 a share, and the stock Tuesday morning ran up 10 1/4 to 35 1/4.