I've been seeing some sentimental indicators related to the options market come across my reader and I thought I would make a few comments.
The chart below shows a Speculative Options Activity index. This is simply the number of opening options transactions that are bullish bets on the market minus those that are bearish on the market. To be more precise, call purchases and put sales are combined (since they both profit if the market rises), and then we subtract the total number of put purchases and call sales (since they both profit if the market falls).
Constructed this way, the indicator will show a high reading if options traders expect the market to rise, and a low reading if they expect it to fall. The chart below shows this measure over the past few years.
Here's my overall thesis with this data: it comes as no surprise that we're seeing a ton of option buying (spec) activity. This data, combined with the fact that there's so much cash sidelined, tells a bit more of the story.
As many funds are still below their watermark and underperforming the markets, they're looking for ways to gain exposure to the overall trend but with keeping risk low. The best way to do this is to buy calls-- especially if you think that the volatility environment will not continue it's downtrend anytime soon. Remember, stocks like AMZN, GOOG and a whole lot of others have vol at 52 week lows, so the premium (while elevated compared to 2yrs ago) still remains fairly cheap.
Another strategy is if you want to enter the stock at a certain price point, you can sell put contracts that will assign you, and you pick up the premium as well.
So the chart above is essentially tracking the synthetic longs-- i.e. the combination of put sales and call buys. Other data (ISEE) shows just call buys and those are quite overbought as well.
The fact that we are at decade-highs for spec option trading makes perfect sense when we consider the fact that there's so much cash on the sidelines. I believe that a ton of people still are skeptical of this rally (reasonable) and they don't want to deploy a ton of cash in the market because they think that a LEH/AIG-esque event is to occur in the fall. Certain option strategies are made exactly for that sort of thesis. While the spec option plays are still a good overbought indicator, but there's an underlying story to tell that explains the data.