Index Option Question

[AlgoJoe]

A few years ago on CNBC a trader was interviewed from the floor and they commented on the near term INDEX OPTION expiration. They referred to the OPEN INTEREST and the dollars that were being deployed to SPREAD the market. (I am a little rusty on my option math) Can anyone offer some insight into the calculations they were referring to? The gist of the report was that the SPX Index had xxx number of call contracts yyy number of put contracts – thus indicating where the general population anticipated the S&P Index by expiration. Does this make sense? Are there any papers on this, do option traders use this in their strategies? Any feedback is greatly appreciated.

[FDAXHunter]

This is called the "Put/Call Ratio". It can be calculated for the volume or open interest (or number of trades, etc).

[nodoodahs]

Tabularize col1=strike price, col2=oi on calls, col3=oi on puts, col4=sum(col2,col3), then graph it as an XY with X=col1.



It could be theorized that the collective view of the "market" or the point at which an index option expiry would cause the least collective pain to options players is either the low point intersection of col2 and col3, or possibly the low point of col4, although those two low points will usually be relatively close together.



I have read several articles about this "max pain" type of theory, and there is a website that devotes itself to using this theory for high-volume tech stocks.  I don't know for certain how powerful this influence is or whether a trading strategy could be built around it.

[chokingvictim]

If you create an account at the CBOE website you get an email everyday with many ratios, this being the first one on the list. I've always wondered if many people look at it and make any decisions based on that ratio.

[nodoodahs]

The simple ratio of puts to calls on the index might not be as telling as trying to find the sweet spot based on the spreads of strike prices on the index open interest.  I dunno which is more predictive, but they are two different analyses.



Now, I have seen the ISEE and equity (not index, but individual equity) put/call ratios used as a contrary indicator for short-term bottoms.  I think that's a valid datapoint to be considered, in context of McClellan, Bullish Percent, TRIN, index volume, and VIX spikes as contrary bottom-finders.

[ig0r]

I haven't done the research myself (perhaps you could enlighten) but I wouldn't imagine this analysis alone being useful. Of course, if you have guys on the floor and know where locals are positioned you will have a much better idea of whether a strike will get pegged