Traders Don’t Care About Protection
The price of the puts compared to calls is 2 standard deviations below the 5 year average as you can see in the chart below. You would think with stocks going up in a straight line, investors would seek to buy protection to lock in their gains. However, euphoria makes investors care less about the downside; stocks haven’t had a 5% correction in almost 400 trading days. Secondly, put buying gets expensive if you must keep rolling it over and it never ends up being worth anything. It’s like buying an expensive back up oxygen tank when you go in a submarine (assuming you need to buy a new one every time you go in it). Shorting the VIX, selling puts, and buying calls have been trades that have worked for a while.
On the other hand, when the indicator below saw put prices increase versus calls, it was a good time to buy stocks. It’s like buying stocks when the VIX goes up or buying the dip in stocks. This indicator is screaming to sell stocks like many other near term trading indicators, but we haven’t seen them accurately predict a sell off in a while.
Using RSI To Predict The End Of Bubbles
The RSI is meant to show how overextended a move in the market is whether it’s to the downside or the upside. It usually focuses on short term performance. The chart below utilizes the 18 month RSI to forecast when stock market bubbles will end. As you can see, the current RSI is above 80. Above 70 is considered overbought. The yellow bars highlight when the RSI got to a slightly higher point than it’s at now. As you can see, the highlighted periods all ended in massive declines. The weakest decline was -19.4% in 1956. This is a scary signal. The only positive this chart shows is that the optimism doesn’t portend an immediate decline. The crash can occur in a few quarters. It’s not surprising to see stocks in such a great bull market since 2009 because the financial crisis caused the RSI index to fall to the lowest level since the Great Depression. This chart uses the Dow, but the other indexes all show the same signs.
