Publish date:

Put-Buying Could Be Signaling a Rally

With just one day remaining for September options, and a potentially volatile triple-expiration looming, some traders see the market signaling a short-term rally.

That signal is coming from an unusually high put/call ratio, the measure of how many put options trade for each call option. A high put/call ratio, in the 40s or above, shows that investors have been less reluctant to play a potential downturn. To the contrarian option trader, those investors are almost always wrong, meaning a rally is in the offing.

That action may be exacerbated by triple-witching, the simultaneous expiration of equity options, index options and index futures. Typically, as professional traders adjust and extend their positions into the next expiration month, underlying stocks can swing dramatically because they're used to offset or hedge their derivatives plays.

On expiration, if puts seem ready to expire worthless in the face of a rally, market makers who sold them can cover their short-stock hedges, adding some octane to the market.

In fact, it could have already begun with the 90-point pop in the

Nasdaq Composite Index

Thursday morning. That strength, however, belied a put/call ratio that showed more than 46% of the options market action in individual stocks focused on puts, which give investors the right to sell shares of a stock at a preset price by a certain time.

The three previous days this week, the put/call ratio finished over .50 and in the prior week, was mostly above .40, as the market meandered.

"Notice the put/call ratio didn't go back down to 32 this morning, it's surprisingly high," said Jay Shartsis, the cynical options strategist at

R.F. Lafferty

in New York. "It's interesting that a rally in the Nasdaq is coming the day before expiration. It could mean that a lot of investors are caught short. That could push the market up."

Put buying is sometimes seen as healthy because if investors are purchasing puts as hedges to the individual stocks they hold, it means that in the event of short-term downswing, they can profit on the put option position without having to liquidate their stock positions.

Some of the stocks where heavy put buying has preceded recent upswings include drug maker

Eli Lilly

(LLY) - Get Report

and

TheStreet Recommends

Amazon

(AMZN) - Get Report

, Shartsis says.

Now he's watching two European telecom giants,

Ericsson

(ERICY)

and

Nokia

(NOK) - Get Report

, where put buying seems to have created a bearish feel.

Both were up today, Nokia rising $1.25 to $44.75 and Ericsson up 50 cents to $19.06, but not enough apparently to keep the put buyers at bay.

Thursday morning, Nokia's October 42 1/2 puts traded 2200 contracts but slipped 5/16 ($31.25) to 1 11/16 ($168.75). On Wednesday, the in-the-money September 45 puts traded 4200 contracts.

Ericsson action was similar. Thursday trading brought volume of more than 3200 contracts to the October 22 1/2 puts, which jumped in price 1/8 ($12.50) to 3 3/4 ($375). On Wednesday, volume in the October 17 1/2 puts accounted for more than 2000 contracts changing hands.

To Shartsis and other contrarians, this "residue of bearishness" means that there's a healthy amount of concern in the overall market.

"There are a lot of way people read indicators like the put/call ratio," he says. "For now, I'll take it at face value."

As originally published, this story contained an error. Please see

Corrections and Clarifications.