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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/