I started at 215 which is "at the money" and the prices above that are the call options, since those are "out of the money". I made the call options green, since they are for upside price action. I then graphed the put options prices from 215 and down and made them red, since they are for downside price action.
What you can see is that it costs a lot more to protect against a market decline than it does for a rally. In fact, if you had $1.65-$1.70 to spend on a CALL option, you could get one that was 3.2% out of the money. But if you bought a PUT option instead, you'd have to get one that was 9.3% out of the money, which is ALMOST 3 TIMES FURTHER OUT OF THE MONEY.
Basically speaking you'd have to monitor this every day to see what was a "normal" amount of skew, or price difference between puts and calls that are out of the money. But I think you can see that this is a pretty extreme reading at first glance. The fact that they are different in price is more of a function of how people use options and who initiates the trade to price the option.
Let's walk through the basics:
A put buyer enters an order to buy a put, which gives a put seller the chance to sell. Once the transaction has occurred, the "put seller" generally would prefer to neutralize the position by either selling short a fractional amount of the index, or go out and purchase other put options to hedge off the risk. So after awhile, a market for options that looks like this would imply that a lot of hedging has taken place and nervous longs and speculators have already built their positions and are protected against a market decline. What I would also expect out of an extreme reading like we have now, is that any sharp decline would find a bottom quickly because the hedges are already in place. This is not to say that we can't have any declines, but you wouldn't expect to see a cascading decline or a massive collapse with this much hedging already in place.
It looks to me that the market will more likely edge higher to the 220-225 area into year end as a much more likely possibility to the 198-206 area. The odds are better than 2:1 that this is true, from the way that I see it.
Have a great weekend and hope to continue doing this analysis each weekend until it shows a signal.
I'll be in KEY HIDDEN LEVELS chat room during the week if you have any questions or feel free, of course, to post questions here.
All the best,
If you pay about 0.9% premium on either side, calls are half the distance from the market. Whereas before it was one-third the distance. Down-spikes find support when put premiums are expensive. The next level is to look for open interest and see if there are any high open interest levels.