Wednesday, March 2, 2011

Stock Market Decline Likely (cont.)

There are two more reasons why a significant decline in stock prices is likely. First, in the context of complacency by investors, is the current ratio of put option volume to call option volume. The put/call ratio is currently at a relatively low level. This indicates that participants in the options market are more concerned with participating in rising stock prices than they are with protecting against falling stock prices. The current level of this ratio is about where it was last April, before the 15-20% decline in major stock market indexes.

Second, corporate insiders are selling stocks at an unusually high level relative to their stock purchases. The current ratio of sales to purchases (nearly 40:1) is well above the level that is normally a level (20:1) that warrants caution. As with the put/call ratio, the current insider sell/buy ratio is at the level of last April, before the sharp drop in stock prices.

These are two more reasons not to be complacent about stock prices in the days ahead. The appropriate strategy is to hedge by raising cash or buying index put options, or more aggressively, to be net short using put options.

Steve Lehman

S & P 500: 1308
Russell 2000: 811

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