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Overreaction in Put Buying Leads to Market Strength

sisyIf the majority of market participants are underexposed to equities, what tends to happen to the market?

It goes higher.

There is a similar tendency in the options market.

If investors load up on puts at any sight of weakness, they become overhedged and therefore underexposed to equities.

This past week, the S&P 500 index corrected almost 2%.

In that same timeframe, the VIX rallied 30%, back to levels from the beginning of the year.

vis

It’s a continuation of the “bullish but cautious” crowd– a pseudo-acceptance of this rally but ready to load up on puts at any sign of weakness.

This is how you can have a non-complacent bull market, the cliched “wall of worry.”

And now the market is gapping up higher, leaving those who bought expensive premiums holding ineffective hedges.

If we ever see a downside move in the S&P with a non-move in the VIX is where you should be concerned– it would indicate acceptance that every dip will be bought.

 

by Steven Place

Steven Place is the founder and head trader at investingwithoptions.com/

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