More on the Low Put/Call Ratio Readings

Last week I noted how the 5-day moving average of the daily CBOE Put/Call Volume Ratio was down to a low level, indicating a lot of optimism among options traders.  That optimism has not yet been punished by the stock market, and indeed we are seeing even lower readings now, both for the 5MA and for the daily readings.

The daily reading on May 14 of 0.696 was the lowest since January 17, 2025, when inauguration day optimism was riding high and the installation of President Trump was believed to usher in the solution to all problems forever.  Optimism like that cannot be sustained forever, and the decline that started in February did a lot to adjust traders' excessive bullishness.

But now that bullishness is back, courtesy of the 19% rally in the SP500 off of the April 8 closing low.  Uptrends will do that.  The nice thing about indicators like the Put/Call Ratio is that it can help us to see when optimism has made too much of a comeback.  That is the message of the current low daily readings, and of the smoothed 5-day moving average.

A low Put/Call Ratio will not tell us, though, when it is going to start to matter.  We have been seeing low readings for a while, and low readings matter.  But they do not have to matter just because we notice them.

I like to say that for the overall stock market, there are only 2 fundamentals that matter.  Forget P/E ratios, dividend yields, book value, etc.  The only 2 fundamentals that matter for the stock market are: (1) How much money is there? and (2) How much does that money want to be invested?

The Fed largely controls factor number 1, with changes in money supply mattering a lot.  QE and QT matter too, as does the soft QE of the reverse repos market.  The Fed also affects factor #2 some, because the Fed's control of short term interest rates means that deposit yields tied to what the Fed does are competing for investor dollars. 

I bring this point up because when you see a very low Put/Call Ratio, or other sentiment extreme, it is a message that Fundamental Factor #2 is stretched about as far as it can be.  Options trading does not affect the factor of how much money there is.  But it tells us about the state of investors' minds, a state which can flip on a dime if given the right incentive.  That's the risk here.