One way to gauge investor sentiment is the put/call options ratio, also known as a bearish-bullish indicator. Anthony Okolie talks to Ben Gossack, Portfolio Manager, TD Asset Management, about the state of the markets, and how he uses options strategies to boost returns and minimize risks in ETFs.
- The S&P 500 has now recovered its losses, and it's back to flat year to date. However, with the new COVID-19 cases growing daily, rising US tensions flaring up, and pending US elections, there's a lot of debate about the direction of the market right now. Ben, you brought a chart looking at investor sentiment. Can you first explain why these charts are important, especially in today's market?
- Hi, Anthony, very good to see you. Yes, right now, if you think about it, we had a sudden plunge in the market in March. We've had a very fast recovery where the market is almost near its all-time high. And one of the ways that we like to look at the market or take a different lens in the market is to understand investor sentiment. And there's many different ways that you can look at investor sentiment.
So, sometimes, we'll look at cash levels in money market funds. We'll look at insider activities. So that's management buying and selling their stock. We'll look at various surveys.
And, because we had such an extreme recovery, the levels that we're seeing in these sentiment indicators are at extreme levels. And there's an opportunity for us to take advantage of these situations.
And so how does looking at options help us understand how an investor's feeling or thinking?
- So we're very active in the options market. For the ETFs that I manage-- that's the TD Active Global Enhanced Dividend ETF and our newly launched TD Active US Enhanced Dividend ETF. And so, if you think about it, the option market provides us another lens. When people are buying put options, they're effectively buying insurance from falling asset prices. And, when they're buying calls, they're trying to get leveraged exposure to rising asset prices.
So, when you take the ratio of puts to calls, you get this industry term called the put/call ratio, but I think a better name is a bearish-to-bullishness indicator. And so what's really interesting is we are near all-time highs, and the indicator that we're seeing for the S&P 500 is actually extreme bullishness in the market, which is actually quite surprising.
I do want to stress one important caveat. Just because we're measuring a lens of bearishness and bullishness in the options market doesn't mean we have a crystal ball into the exact direction of where the market is going to go in the future.
- Ben, as you mentioned, you employ options in your ETF strategies. Can you walk us through this chart that shows the put/call ratio for Apple? Kind of walk us through it, and tell us what it means.
- Sure, so we have this phenomenon of extreme bullishness at the top of the market. But, in our ETF, we focus on individual stocks because we're trying to write these contracts to enhance the income that we're receiving on our dividends. So I brought a chart looking at the put/call ratio for Apple. Maybe we'll just take a moment to just sort of orient ourselves.
We are comparing the prices that investors will pay for the protection after a 10% loss and also for leveraged exposure to Apple above a 10% gain. If you think about it, when you look at the mean of our chart, it's about 1.35%. And, if you think about behavioral finance, investors will pay up to protect themselves from losses. Investors feel losses more than they feel sort of the benefit and the win from gains. So there's this natural sort of premium that's provided in these put options.
And so I'd say, within that one standard deviation movement, that's just daily shifts between sort of bulls and bears, and there's not much to be gleaned. But it's, when we hit these extreme levels, stuff that we saw in January and March and today, there's a really big opportunity for us to take advantage of that for our ETF and earn enhanced income.
OK, so now that we understand how to read this chart, how do you apply this in your portfolios?
- Right, so let's go back to March. We had extreme bearishness, given the uncertainty about the virus transmission, what lockdowns would do to the economic situation. And stocks plunged in March, and you can see that chart spike all the way to the top.
So, the higher that we go on the chart, the more bearishness there is in the market. And so we are providing those puts to the investors that wanted protection from Apple falling, its price level from falling on them. And so, pre-COVID, our put-writing program would give us sort of a mid-teens yield. And so, during that March sell-off, we were seeing multiples of that yield, which meant more income for our unit holders.
Conversely, what I find very interesting today is we went from extreme bearishness, and we've now moved to the bottom of the chart today where we're seeing extreme bullishness in Apple, even with Apple already trading close to its all-time high. Again, we were also-- we're providing that protection to investors, but we're also providing that leveraged exposure to investors that want to get more exposure to Apple.
And so, for out call-writing program, again, pre-COVID, we would have seen sort of a mid-single-digit type yield from our program. Today, we're getting multiples of that in yield. And, because there's extreme bullishness into Apple, we're able to give ourselves more cover. So, when we write these contracts, we're, effectively, going to sell our Apple shares to these investors. We can set that price at a much higher level, which goes back to our objective, which is to earn income, but also provide and participate in price return for our unit-holders.
And where's the interest in Apple coming from?
- Right, so, if I knew that exactly, it would be amazing. Unfortunately, we just do not have that level of detail. But one thing that we have seen within the sell off and recovery has been a return and an increased participation of the retail investor. One way that we're seeing that is just sort of trading volumes, but, particularly in the option market, if you think about it, one option contract is about 100 shares. And so we're seeing a lot of volume of activity in sort of the lower-- sort of lower-denominated contracts.
For Apple, the notional amount of one contract is about $37,000 US dollars. And I think that's pretty attainable for many investors to trade one contract, but, when you get to 10, we're talking about $370,000. And so that starts to push it out of realm for average investors, so a lot of activity in one contract, two contracts, three contracts that we haven't seen for many years, for quite a while.
Ben, thanks very much for your insights on this sentiment indicator.
- Great, thanks for having me, Anthony.