Why Is the Put-Call Ratio (Fear Gauge) Higher Than in the Lehman Collapse of 2008?

The rising fear may reflect a shift in sentiment from faith in the omnipotence of central banks to skepticism.

By at least one well-known measure of sentiment, the level of fear in the stock market now exceeds the fear triggered by the collapse of Lehman Brothers in September 2008. Lehman declared bankruptcy on September 15, 2008, unleashing a cascade that soon threatened to take down the entire global financial system.

There is no comparable event--or level of fear--other than the Great Crash of 1929.

Thus it is extraordinary that yesterday's CBOE put-call ratio of 1.53 exceeded the put-call ratios of the 2008 global financial meltdown, which topped at 1.52.

What is the put-call ratio? Here is the standard definition: The Chicago Board Options Exchange's (CBOE) put/call ratio (or put–call ratio, PCR) is a technical indicator that reflects investors' sentiment. The ratio represents a proportion between all the put options and all the call options purchased on any given day.

Puts are options that increase in value as stocks decline. Calls are options that increase in value as stocks rise. So if punters reckon the market will fall, they buy more puts (bets the market will drop) than calls (bets the market will rise).

There is no one ideal measure of sentiment. Participants buy options to protect or hedge their portfolios as well as to speculate on market moves, so the put-call ratio reflects a wide range of motivations and emotions. Nonetheless, it serves as a rough-and-ready thermometer of participants' fear and panic.

Anyone can download the CBOE put-call ratio data from November 1, 2006 to the present on the CBOE website and display it in an Excel spreadsheet.

If you sort the 2,003 records from highest to the lowest, you find that the only days in that time period where the put-call ratio exceeded the Lehman collapse and yesterday, October 13, 2014, are three days in early 2007, when the first indications that the wheels were coming off the subprime mortgage market and the housing bubble hit the news. (Those three days registered the only PCRs above 1.53: 1.61, 1.65 and 1.68.)

A mere 28 of those 2,003 days registered put-call ratios of 1.40 or higher. Only 12 days registered PCRs of 1.50 or higher. So clearly, the current level of fear is noteworthy.

What has spooked punters to levels not seen since the global financial system was tottering in October 2008? Are the current set of global risks really equivalent to the implosion of the entire global financial system? Punters seem to think so.

Perhaps what is different from 2008 is the constellation of global risks, which now include a deadly viral epidemic (Ebola) and geopolitical conflicts as well as a softening global economy.

The rising fear may reflect a shift in sentiment from faith in the omnipotence of central banks to skepticism. After all, if central banks can't guarantee markets will loft ever higher, then what is keeping them at current levels? The usual answers-- corporate profits and future earnings--are contingent on the global economy, which appears to be rolling over into recession or stagnation--not the ideal set-up for higher future profits.

I also wonder if the current spike in fear also reflects a new skittishness, as if participants are keenly aware the whole contraption is shaky and so they are primed to sprint to the exits now rather than risk being crushed in the mob.

There is some irony in this nervousness, for if central banks hadn't been so obsessed with levitating markets higher for the past 6 years by hook or by crook (ahem), perhaps markets wouldn't be so fearful of a collapse.

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