Wednesday, March 5, 2008

Filet Mignon

In earlier posts I made mention of the fact that traders have been selling puts into each decline. That seems to me to be risking dollars to make nickels. Above is a snapshot of the Shaeffer's Open Interest (put/call) Ratio for QQQQ which shows this ratio is at it's lowest level in the past year. The current SOIR is 1.25 and the 1 year rank is 1% meaning that 99% of the time the ratio has been higher. On the 2 year chart the SOIR ratio is in blue.

Selling puts into a decline is risky business. Essentially you are providing downside risk insurance to other investors (and/or removing your hedges) on the premise that there won't be continued downside.

For the past 4 years this strategy has been working great, but it's one of those things that works great until that one day when it blows up in your face. It's kind of like eating Filet Mignon every day - it's a great idea for a long time and then all of a sudden comes that heart attack...