Bullish Signal on Small Caps

As a bull, it was nice to have an up day after what seemed to be an intolerable losing streak.  It’s funny how I did not see one new article mention 1987, 2001, or 2008 yesterday in cyberspace.  The real question is this temporary set-back a sign of a bear turn, or just the normal summer sale finally happening coupled in with some minor fear about Big Bad Uncle Ben?

We decided to look at one of our favorite metrics in technical analysis/behavioral finance for follow the smart money; the put-call ratio.  In order to avoid reinventing the wheel here is the simple definition from Investopedia:

A ratio of the trading volume of put options to call options. The put-call ratio has long been viewed as an indicator of investor sentiment in the markets. Times where the number of traded call options outpaces the number of traded put options would signal a bullish sentiment, and vice versa.

Here is some data from analysis of our benchmark the Russell 2000 Index, in which we looked at its proxy, the iShares Russell 2000 Index Fund (NYSE AMEX – IWM), which closed yesterday at $102.10, up nearly 16% for 2013.  This is crucial as sentiment on small cap stocks typically turns goes bearish before the rest of the broader market.

One month:

The September 2013 IWM strike price of $103.50 is about a 1.3% increase from current prices, or, follow the logic, about one month of return at current 2013 pace.  Put volume was  1,605 versus call volume of 4,452. Very Bullish.

Three-months:

Using the same logic above, we looked at the November 2013 strike of $108.  Put volume 1,011, call volume 2,086. Bullish.

Are we saying that IWM is set for another 16% run over the course of the next year due to these figures?  IWM may go another roll, but we would never base that on solely this metric alone as there are several limitations to it and tracking volume at a range of strike prices and expiration months over several sessions is the more prudent way to utilize it.  However, a quick sanity check always is a good idea. 

In case you were wondering, we are still bullish on small caps through the rest of the year.

Have a great day.

Disclosure: Goldman Small Cap Research analysts are neither long nor short these shares but may elect to purchase the stock within the next 48 hours.

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