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Today's Biggest Bets Against the Crowd

By Tom Dyson, publisher, The Palm Beach Letter
Monday, December 14, 2009

I hope you haven't bought silver....

As I'll show you in a minute, right now, traders are making far more bullish bets than bearish bets in silver.

So if you're a contrarian trader, you should be selling silver, not buying it.

What about financial stocks? Traders are much more interested in the short side of financial stocks than the long side.

Contrarians should be buying banking stocks, not selling them.

If you can time it right, the surest way for you to make a quick buck in the stock market is to bet against the crowd at extremes. When you see traders all piling onto the long side of the market and ignoring the short side, you know betting on the short side is more likely to show the profit. This is called contrarian trading.

Today's contrarian indicator comes from the options market. The options market is great for measuring sentiment. It is much more speculative than the stock market. Traders make crazy bets on short-term outcomes, using lots of leverage. They wear their hearts on their sleeves. Also, the options market is a zero-sum game. One trader's profit is another trader's loss. So it's always clear who the bears are and who the bulls are.

To tell which side of a trade is popular, simply compare the prices of call options with the prices of put options. Call options are bets stock prices are going to rise. Put options are bets the prices are going to fall. If call options are more expensive than put options, you know there's more demand for them than demand for put options.

Let's take financial stocks as our example. We'll use IYF. It's the iShares exchange-traded fund (ETF) for the large banks and brokers. (I recorded the prices at last Thursday's close.)

Bet

Cost

IYF rises 10% by March

$0.80

IYF falls 10% by March

$1.25

As you can see, making the bearish option bet costs over 50% times more money than the bullish option bet. Therefore, the bearish bet is far more popular than the bullish bet among option traders.

Let's repeat this exercise with silver, using the silver fund (SLV) as our proxy...

Bet

Cost

SLV rises 10% by April

$0.92

SLV falls 10% by April

$0.67

In banks, the bearish trade was more popular. It's the opposite case with silver. The bullish bet costs almost 40% more than the bearish bet. There must be many more bulls than bears in silver.

I repeated this exercise with ETFs for the S&P, gold, oil, real estate, Chinese stocks, Russian stocks, and gold stocks. I compared option strike prices 10% above and 10% below the current price, with maturities between February 2010 and April 2010. Here's what I found...

Fund Which costs more? By how much? Therefore, the crowd is...
Financials

IYF

Put option

56%

Bearish
Silver

SLV

Call option

37%

Bullish
Gold

GLD

Call option

26%

Bullish
Stocks

SPY

Put option

174%

Very bearish
Oil

USO

Balanced

0%

Neutral
Real Estate

IYR

Put option

37%

Bearish
China

FXP

Put option

44%

Bearish
Russia

RSX

Put option

18%

Bearish
Gold stocks

GDX

Balanced

0%

Neutral

Of all the investments I looked at, the S&P 500 and gold produced the most interesting results. On Thursday night, when I worked on this, it was a coincidence SPY (the S&P 500 fund) and GLD (the biggest gold fund) both closed the trading session with the same price per share... $111. But look how different their March 2010 option prices were...

With both GLD and SPY trading at $111, the...
  • GLD $120 call option was $3.09

  • SPY $120 call option was $1.25

  • GLD $100 put option was $2.08

  • SPY $100 put option was $2.30
Look at the GLD call option. It's almost three times more expensive than the SPY option. On the other hand, the SPY put option is more expensive than the GLD put option.

Said another way, gold is a lot more popular than the S&P 500 among options traders right now.

I'm not saying you should short gold or buy the S&P 500 immediately. I'm merely pointing out sentiment is lopsided right now in these two investments. If you're a contrarian, trade accordingly.

Good investing,

Tom




Market Notes


NEW HIGHS OF NOTE LAST WEEK

Agrium (AGU)... fertilizer
Potash (POT)... fertilizer
Cigna (CI)... health care
WellPoint (WLP)... health care
UnitedHealth Group (UNH)... health care
Disney (DIS)... entertainment
Starbucks (SBUX)... deficit coffee spending
Canadian Pacific Railway (CP)... railroads
Burlington Northern Santa Fe (BNI)... railroads
Verizon (VZ)... telecom
High Yield Bond ETF (HYG)... bonds are being paid back
Dillard's (DDS)... department stores
International Royalty (ROY)... Dan Ferris was right!
NetApp (NTAP)... data storage
Southwest Airlines (LUV)... airline
Duke Energy (DUK)... utilities
TransCanada (TRP)... pipelines
El Paso Pipeline (EPB)... pipelines
Enbridge Energy (EEQ)... pipelines
Williams Partners (WPZ)... pipelines
Sunoco Logistics Partners (SXL)... pipelines

NEW LOWS OF NOTE LAST WEEK

Alon USA Energy (ALJ)... oil refining
First California Financial (FCAL)... bank
Central Virginia Bancshares (CVBK)... bank

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