Searching for Losses

"I’m recommending put options on Google…" my friend Porter Stansberry told me two weeks ago… "So my readers can make triple-digit profits as shares fall back to earth." I replied, "Okay, Porter… But isn’t that like standing in front of a freight train right now?"

It may be out of gas, he tells me. "Steve, a secret signal you showed me years ago, plus the activity in its options, tells me that we’ve seen the top in that stock…"

I can’t tell you the secret indicator. But I can share with you what the options trading in the world’s most widely used search engine may be telling us about where the stock price is headed…

And I can show you how to track the options activity in the stocks you own, employing the put call ratio, to help determine when they might change directions on you.

I find the chart below fascinating…

The red line is our stock’s share price, while the blue line is the stock’s put call ratio for options.

Simply said, when the blue line gets extremely high, it’s time for the stock to rally. And when the blue line gets extremely low, it’s time for the stock to crash.

I’ll explain why in a minute. But first, take a look at the chart below… When the blue line peaked two years ago (at the beginning of this chart), shares of its stock jumped from $100 to $200 a share in no time. Now, today, the blue line is at all-time lows. Time for it to tank?

The blue line on the above chart shows the trading volume in stock options. When the blue line is at a high extreme, everyone is betting our stock will crash. And of course, it’s then a great time to trade on the opposite outcome.

When the blue line is at a low extreme, everyone is betting on GOOG soaring. And chances are, the opposite will happen. The "put call ratio," as it’s called, can be used as one gauge of investor sentiment. When the put call ratio reaches extremes in either direction, it can signal a turning point in the stock’s direction.

The put call ratio is telling us that many more people are betting on shares of GOOG to rise rather than fall. Since "the crowd" now believes that the stock will rise, we may be at an extreme that signals a turning point: it may be time to go against the crowd.

Another way to check out the extreme in optimism is to look at where these options traders have placed their bets. As I write, we’re talking in the area of $280 a share.

Talk about optimism… As you can see from the chart below, there are many people betting on shares exceeding $380 a share, by mid-July! Now, that’s optimism!

In fact, one friend of mine, Jason Goepfert of SentimenTrader.com, is fully aware of this. So he’s made a few "tweaks" to the classic put call ratios to make them more useful. He’s devising new put call indicators to specifically target what the "dumb" money is doing now…

For example, one of Jason’s indicators is his "ROBO" put call ratio. "ROBO" stands for "retail-only, buy-only." Jason isolates the small options trades (trades of 10 contracts or less – "retail only"), and he only looks at people making "buy" orders (instead of short-selling options – "buy only").

This way, he figures, he’s getting at what the "retail investor" – the "dumb" money in the options market – is doing with his money.

Jason’s ROBO stock put call ratio has accurately picked the major tops and bottoms. As Jason says in his description of the ROBO put call ratio on his web site:

"At the height of the stock market bubble, retail traders were going crazy over call options. For the week ended April 7, 2000, they bought to open 1,380,000 calls and only 237,000 puts, for a put call ratio of 0.17. They were so delirious with lust that they were willing to pay an average premium of $814 per call contract to be in the game. They paid an average of $599 at the time for their puts. So they were buying nearly six times as many calls as puts, and paying 36% more for the right to do so."

"At an opposite extreme, the week ended October 11, 2002, they bought to open 430,000 calls with an average premium of $182. During the same week, they bought 508,000 puts for an average of $250. So they were willing to pay 35% more for protection than they were for potential upside – the opposite of what they were doing during the bubble."

When you’re trying to gauge the end of a move (in either direction) in a stock (or the overall market), put call ratios are a useful arrow in your quiver. They shouldn’t be used by themselves, but their message shouldn’t be ignored either.

In summary, the put call ratios we use in our example today suggest GOOG may be "over-loved" and ripe for a fall. My friend Porter’s call might not be that crazy after all. Are your stocks ready for a fall, too? Find out…

The European Constitution was a shambles from the beginning…

There was no agreement on the issues that the Constitution should decide or the principles by which they were to be decided. The drafting was controlled by ex-President, Valery Giscard d’Estaing, from the top. Little or no attention was paid to proposals that did not come from the Franco-German group, which dominated the presidium. The result was a lengthy and confused document that made no contribution to democracy or efficiency, which had been the objectives of the Laeken agreement.

The heads of governments all signed the treaty, supposed to be a second Treaty of Rome, in the summer of 2004. Those who avoided a referendum were able to get the treaty ratified in their parliaments, but only in Spain was it possible to win a referendum of the people at large. In France and the Netherlands, which were supposed to lead the way to ratification, a referendum produced a large “non” majority.

Those of us who had been opposed to the Constitution from the beginning had felt that it was incoherent, undemocratic, and fatally opposed to the independence of the European nations. We were not surprised that it proved to be unacceptable, even to the founding nations of the European Union. Opinion polls suggest that it would have been rejected by the Germans if Germany had also had a referendum.

In Britain, Prime Minister Tony Blair agreed to a referendum because he wanted to push the European issue beyond the general election. In that, he was successful, but he could not have won a referendum if one had eventually been held.

From our point of view, the defeat of the Constitution in France and the Netherlands was, therefore, welcome. Yet I do not think that most of us expected to see Europe collapse into such a storm of recriminations.

The British are blaming the French, and I think they are justified. The Constitution was a French affair, from beginning to end. The idea was pushed by the French; it was largely drafted by the French; an ex-president of France was in the chair; and the president of France decided to hold a referendum, and he lost it.

In order to mitigate the political embarrassment, President Jacques Chirac then attacked the British rebate. He used a row over the European budget to cover his embarrassment over the Constitution. Tony Blair has responded by attacking France’s benefits under the Common Agricultural Policy.

Europe has, of course, been through these internal disputes before, but this is a worse, and angrier, dispute than has occurred in a long time. Many observers feel, and the British hope, that it will lead to a looser Europe, more like a free trade area than a United States of Europe. It makes it much less likely that Turkey, which is not, after all, a European power, will be allowed to join.

But the commission, the council of ministers, the parliament, and the European Court of Justice are all still there. So are the many “good Europeans” who believe in the “European project.” So is the euro – though that, too, is being questioned. The project of integration has suffered a setback, but it has not gone away, though the balance of probability has swung against it.

And the Markets…