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Options Pros Less Fearful Now, but With Expiration Looming, Concern Remains

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Although sentiment indicators continued to ease, showing the market was feeling less fear Wednesday than Monday, when it was rocked by election jitters, some options-market pros said there was still a strong undercurrent of concern about the market's condition.

"It seems like people are very cautious this week for expiration," said Martin Galivan, a floor broker with

Investec Ernst

. Equity options and some index options expire Friday.

The

Chicago Board Options Exchange

equity put/call ratio, which soared and closed at 0.77 on Monday, dropped back closer to 0.50 Wednesday. From a contrarian point of view, a high equity put/call ratio is positive, because it indicates a lot of negativity in the market. To contrarian investors and traders, who believe strong sentiment in one direction is a signal that a cycle is ending and a stock or sector will soon reverse course, excessive loathing for a stock or the market is bullish.

Elsewhere, the

CBOE Volatility Index

, or VIX, which surged to the mid-30s on Monday, has declined sharply with the market's recent advance, indicating there's less fear and anxiety in the market. Generally, the VIX rises when put buying increases on options on the

S&P 100

, or OEX, which trade at the CBOE. A put option gives the purchaser the right, but not the obligation, to sell a security for a specified price at a certain time. For contrarians, low readings on the VIX are bearish, while high readings are bullish.

Meanwhile, Scott Fullman, chief options strategist at

Swiss American Securities

, thinks the market will be volatile through expiration. Longer term, he sees the market going higher.

Fullman said that due to the slowing economy and uncertainty surrounding the presidential election, investors are a little nervous and staying on the sidelines. On days when the market drops sharply, few buyers are willing to step in, he noted.

TheStreet Recommends

For the

Nasdaq Composite Index

, the best thing for the market right now would be a washout, says Bernie Schaeffer, chairman and CEO of

Schaeffer's Investment Research

.

"My feeling is, it would probably be the most healthy if we just gave it up," Schaeffer said Tuesday in an interview. "If we just gave up this 3000 stuff, and we got down to about 2500, 2600," it would essentially cancel out October 1999 to date. With such a downdraft, he'd like to see a few other things too, such as high equity put/call numbers, bearish advisers outnumbering bullish advisers, and high-profile strategists pulling in their horns. Also, he'd like to see some real fear in terms of some equity fund outflows.

"To me that could just set the slate clean," he said. As an added bonus, it would be nice if the Fed comes around to being friendly to the market.

Schaeffer is heartened by levels on the CBOE equity put/call ratio, a classic sentiment indicator. He looks for the ratio's 21-day moving average to hit a recognizable peak, and then have it roll over, which it has done. Now, the put/call reading is flashing a buy signal.

However, there's still plenty of things that trouble him about the market. While the put/call ratio is quantitative, there are other sentiment indicators that are less quantitative that Schaeffer doesn't like. Among some of those indicators, he mentioned the latest

Investors Intelligence

survey of financial advisers, which showed advisers who were bearish coming in under 30%, and the fact that Wall Street strategists' average recommended allocation for stocks is near a record high, which says to him there "doesn't seem to be any capitulation from that quarter."

As for areas in the market that look good right now, Schaeffer said he finds the biotechs intriguing. He noted the big selloff Monday on huge volume in the wake of a negative

Barron's

article on the sector. The sector could've put in a major bottom Monday based on the panic generated from the article and there's "good recovery potential there," he said. His favorite stock in the group is

Genentech

(DNA)

. He also said he likes the

Biotech HOLDRs

(BBH) - Get VanEck Biotech ETF Report

, which offer investors a "nice diversification" in the sector.

Elsewhere, he likes

Palm

(PALM)

, which he sees as a nice long-term play, in part because sentiment has been skeptical on the stock for the longest time and the stock has been in a nice up-trend. Another pick is

Amazon.com

(AMZN) - Get Amazon.com, Inc. Report

.

He's also bullish on some drug stocks, particularly

Merck

(MRK) - Get Merck & Co., Inc. Report

,

Abbott Laboratories

(ABT) - Get Abbott Laboratories Report

and

Alza

(AZA)

. He said there's been a lot of put activity on those stocks, at the same time they're breaking out to all-time highs. "That's kind of my classic bullish scenario," Schaeffer said.

What's he avoiding?

"I would avoid the so-called Four Horsemen," he said. "

Sun

(SUNW) - Get Sunworks, Inc. Report

,

Oracle

(ORCL) - Get Oracle Corporation Report

,

Cisco

(CSCO) - Get Cisco Systems, Inc. Report

and

EMC

(EMC)

.

"I don't know how much more downside there is. But I don't see them being leaders and even if we are recovering, I don't see them as leaders."