Feb

17

The options viewpoint.

Point 1: Virtually any macro investment strategy can be replicated with options. (Previously stated by one brighter than I.)

Point 2: The use of options can enable the strategist to hide his moves.

Point 3: Options transactions tend to be the milieu of the professional.

Possible conclusion: The broad analysis of options transactions can reveal some interesting truths about the current investment environment.

We have studied the broad pattern of equity options transactions this century and have found whichever side creates more options positions is correct. That is, the condition where new positions consistently exceed liquidations. This is equivalent to a shorter age or holding time (open interest divided by new positions). "Whomever holds longer is wronger" to coin a cheeky phrase. Specifically, if the turnover rate is higher for calls than puts, it's generally safe to be long.

Being long equities when the bullish patterns existed (since 2000) yielded a compound annual rate of return of 11.5 percent. Being short equities during the bear patterns yielded 3.5 percent (CAROR), such that the combined compound annual ROR was 15 percent. Not bad. The trouble for statisticians is that there aren't many switches (less than 40), making statistical reliability problematic. But the minimized "signal flutter" is comforting to longer term investors.

Although this metric called the 2009 turnaround on the money, it should be used to check the climate rather than the weather. Where are we now? Very close to going long. I would be reluctant to give a heads-up in advance of the actual signal, except the chart I show is a smoothed version. The unsmoothed version is already positive.

Here are two charts (2009 and current).


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