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September 30, 2001

Options Bear and Guru

By Kathryn M. Welling

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Bernie Schaeffer, the major domo at Cincinnati-based Schaeffer's Investment Research, is an options guru, a market technician, a natural-born contrarian, a gentleman and a scholar. He has also, since last March, been a bear, quite a transition for a market analyst who'd stayed doughtily bullish through most of the bull's decade-long romp.

But that doesn't bother him. What does, currently, is the complacency he detects among institutional investors, especially in the way they've been piling into riskless' options strategies in a trendless' market that's just broken some longstanding support levels.


What's your take on investor sentiment here, Bernie?

Still way too complacent. But then, why not, with Wall Street strategists recommending allocations of 72 percent to stocks, 3.8 percent to cash? I think, though, that we're in a very high-risk environment. I would point out to you what we are seeing in options sentiment. That is, the 21-day moving average of the CBOE equity put/call ratio. We look at it as an overall market-timing indicator, looking for indications of when sentiment is getting extreme. We've got data on it going back to 1990. What we are seeing is an interesting phenomenon, which is not surprising, when you think about bull and bear market dynamics. What seems to be happening is that, over the past few years, the peaks are starting to get higher and the bottoms are starting to get higher as well.

Why should that be?

Well, you would expect, as you move from a bull into a bear market environment, that when people get extremely bearish, their bearishness would go to even greater levels than it got to when they were getting bearish before. And people would never quite get as bullish, when they're feeling better in a bear market, as they used to get when they were feeling good in a bull market. That's what's happening. We recently got a bottom in the equity put/call ratio at about 0.6, which used to be a level where you would put in some nice peaks. But that's where it actually bottomed. We now have moved into the mid-0.60s on it. I suspect, if some of these negative possibilities come together, we could see the put/call ratio going to some sort of record, which would have people calling a bottom in the market, because the put/call ratio went so high. But all it would really mean is that, very understandably, as the bear market continued to knock stocks down, people were getting more bearish. It wouldn't mean that they are as bearish as they'll ever be. Simply, that as they recognize the bear, they get more bearish. So it'll be interesting to see if we put in a new high in the 21-day moving average of the put/call ratio, if this market continues to frustrate from here.

What else makes you think investor sentiment is still disturbingly complacent?