A Useful Stock-Picking Tool

In the most recent edition of The Goldman Guide we reviewed P’s related to traits for today’s successful investor, Patience, Prudence, and Productivity.  We emphasized doing your homework as part of prudence.

One tool as part of doing your homework you might add is the Behavioral Finance idea of following the smart money, and looking at another P, Put-Call Ratio.  While no metric is the absolute way to trade or invest, this will give you a good idea of how seasoned traders and investor s approach your stocks.  Think of it as another check in the due diligence box, especially for those engaged in more than your run-of-the-mill trading strategies.

Simply ‘put’, it works this way.  Go to any site like Yahoo! Finance or Google Finance, pick a stock, and go to the option chain.  The put-call ratio is a comparison or simple division of the volume of puts over the volume of calls at a given strike price and expiration date.  If the number is greater than one this is bearish and a number smaller one is bullish.  Like all other metrics it is key to use a relative measure if you are comparing a few stocks and cannot be used in a vacuum.

One nice feature of the put-call ratio is the built in time factor for your trade or investing duration, as you compare the expiration date of given options.  So traders can look at 30 or 60 day dates, while investors might go further out.

If you look at some of the figures on recent Market Monitor-featured bio-tech stocks, you will see that all of them demonstrate bullish traits if you compare for example the June 2013 our expiration date and a stock price approximately 30% higher than the current level and matched it with the appropriate strike price. The level of bullishness has varyng orders of magnitude but still, it affirms that the space is under accumulation.

One drawback in our small cap space is that not all of our stocks have options and when they do, it is not uncommon that there is not that a great number of contracts available.  Otherwise, the put-call ratio is another tool to put in the toolbox related to Prudence.

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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