Using Options to Find Investor Sentiment Extremes

Option open interest is the number of outstanding calls or puts that have been bought or sold to open, but have yet to expire or be closed. To analyze stocks, we often use option open interest as a means of measuring the relative levels of investor optimism and pessimism. More specifically, we utilize the Schaeffer's put/call open interest ratio (SOIR) as a sentiment indicator to gauge near-term traders' expectations. Below, we will review the basics of the SOIR, while looking at examples of stocks with extreme SOIR readings right now.

SOIR Basics

The SOIR measures short-term options open interest, comparing the number of open put contracts to the number of open call contracts that are set to expire in the next three months. A stock's SOIR lets us see how traders with short-term objectives are positioning themselves in terms of being call- or put-heavy.

More specifically, a SOIR reading above 1.0 means that puts are more prevalent than calls among near-term options. On the other end of the scale, readings below 1.0 indicate that calls are more popular.

Even more telling, perhaps, is where the SOIR for a given security stands relative to its own 52-week range, as this indicates whether near-term traders are favoring puts or calls by a wider-than-usual margin. A SOIR with an annual percentile rank of 0% reveals that calls are currently outnumbering puts by an extreme margin, while a SOIR above 100% of the past year's worth of readings suggests short-term traders are favoring puts over calls at a climactic rate.

However, it should be noted that the SOIR includes both bought and sold options. As such, this metric should be used in concert with other technical and sentiment indicators to paint the fullest possible picture.

Stocks With Extreme SOIRs

Looking at only stocks that carry at least 10,000 contracts of open interest, below is a list of equities with extremely high or low SOIRs right now, with data provided by Schaeffer's Senior Quantitative Analyst Rocky White.

Agilent Technologies (NYSE:A)stock's SOIR sits at a lofty 8.74, and ranks in the 100th percentile of its annual range. In plain words, this means that near-term options traders were unusually put-skewed toward the stock, compared to the past year, as of Feb. 6.

Switching to the stocks with the lowest SOIR percentages, we will narrow in on exchange operator CME Group (NASDAQ:CME). Ranking in the lowest possible percentile for its annual range, CME's SOIR of 0.33 is a clear indicator that short-term speculators have rarely been more call-skewed toward the stock during the past 12 months.

It's vital to keep in mind that no indicator, taken out of context, offers a complete picture of options activity. Open interest configurations can be revealing in many ways, but it's important to use this data point as just one of many tools as you analyze potential trade candidates.