Byron Wien believes the bearishness in U.S. stocks is overdone and that the extreme premiums in the put options market could be forecasting the next leg higher:
“People are trying to protect themselves and they are willing to overpay for it.”
Contracts that pay off should the benchmark index for U.S. stocks plunge more than 23 percent from its April high cost 75 percent more than those speculating on gains, the biggest premium ever, according to data compiled by Bloomberg and OptionMetrics LLC. The 10-day average difference exceeded 50 percent 34 times since 1996. In those cases, the Standard & Poor’s 500 Index gained a median 7.2 percent in six months.
Wien says the gap shows Europe’s debt crisis caused too much pessimism in the U.S., where S&P 500 companies are forecast to post 38 percent profit growth in two years. Rising demand for insurance shows investors unwilling to sell stocks have hedged against losses, according to New York-based Morgan Stanley.”
Bloomberg notes the very bullish odds in such an instance:
“When bearish puts cost 50 percent more than bullish calls, the S&P 500 rallied 28 times during the next six months and declined 6 times, according to OptionMetrics data going back to 1996 compiled by Bloomberg. The biggest gain started in November 1997, when the index rose 18 percent and the premium increased to 54.1 percent, data show. The S&P 500 plunged 35 percent after the skew reached 50.2 percent in June 2008.”
Source: Bloomberg
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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