Market Sentiment Through Options Activity: Riding the Tide
Ever wondered if the secret to predicting market trends lies hidden within options trading? Discover how our Market Flow indicator can reveal the true market sentiment behind every trade.
Daily Aggregated Premium and Volume Indicator
The indicator tracks the daily aggregated premium and volume of option trades. It calculates the difference between the value of options traded at (or near) the ask price and those traded at (or near) the bid price.
Example: Suppose $15,000 in call options are transacted at the ask price and $10,000 at the bid price. The aggregated call premium is:
$15,000 - $10,000 = $5,000
This difference represents the net call premium.
Example: If $10,000 in put options are transacted at the ask price and $20,000 at the bid price, the aggregated put premium is:
$10,000 - $20,000 = -$10,000
This result is understood as the net put premium.
In general, more call options purchased at the ask indicate bullish sentiment, while a higher number of puts at the ask suggest bearish sentiment. When both values are similar, the market sentiment is neutral. Diverging trends signal an escalation in bullish or bearish sentiment.
Indicators of Bearish Sentiment
- A rapid decline in the aggregated net call premium.
- A sharp increase in the aggregated net put premium.
As illustrated in the chart below, a swift rise in the net put premium combined with a decline in the net call premium typically signals a bearish sentiment for the S&P 500, with price movements reflecting this sentiment.
Additionally, you can identify which stocks are driving market sentiment by examining the net call and net put premiums of the top 10 stocks by volume. The sections below display the top 10 stocks with the most positive and most negative sentiments.
This insight helps in pinpointing potential bullish and bearish stocks based on the actions of major market players. It’s important to note that a stock’s percentage price change might not always align with its net premium sentiment. For example, a stock may show a positive net premium (indicating bullish sentiment) even if its current price is declining. This suggests that significant investors, such as hedge funds, might be positioning for bullish movements in the coming days, weeks, or months, depending on the expiration dates of their options.
The volume indicator is calculated as the difference between the aggregated call and put volumes, applying similar principles as those used in premium calculations.
Example: Suppose there are 10,000 more calls and 5,000 more puts transacted at the ask compared to the bid. The aggregated volume is:
10,000 - 5,000 = 5,000
Since not all options are priced equally, it is essential to consider both premium and volume for a complete picture.
Conclusion
- Comprehensive Sentiment Analysis: The Market Flow indicator measures market sentiment by comparing the premiums of options traded at the ask and bid prices.
- Bullish vs. Bearish Signals: A positive net call premium indicates bullish sentiment, whereas a positive net put premium signals bearish sentiment.
- Diverging Trends: Rapid changes—such as a decline in call premium and an increase in put premium—serve as key indicators of a shifting market outlook.
- Stock-Specific Insights: Evaluating the net premiums of the top 10 stocks by volume can highlight which stocks are leading market sentiment.
- Volume and Premium Together: For an accurate interpretation of market dynamics, it is crucial to analyze both the premium and volume data.