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Tutorial on Dollar Weighted NDX Put/Call Ratios
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Professional Trader Scott McCray trades NDX index options and uses the Hamzei Analytics' NDX Dollar Weighted Put/Call Ratio to his advantage. Here is how he uses this product:
"One of the indicators I check every fifteen minutes throughout the day is the Real-Time NDX Dollar Weighted Put/Call Ratio (DWPCR). For the most part, I have found that this works as a contrary indicator when the market gets to very extreme levels. When this indicator hits a level of 30 to 1 on the put side, I have found it to be unsustainable, as it shows the bears pressing their bets and pressing them hard.

When I see this, I usually go right to the CBOE website and see where the action is. Is it in the current month or further out? Are they deep in the money options or some speculator buying thousands of cheap options? These are things I want to know before I put my money on the line.

Action like this is ripe for a snap-back reversal caused by a domino effect of short covering and buying, which usually moves the NDX around 100 to 300 points over a couple of days. Each time this indicator hits a level of 30 or higher, I rapidly cover my shorts no matter how ugly the tape is and I get long. I guess you could say that I'm doing the proverbial Zag when everyone else is Zigging. So far, on the five occasions since this information has been available, it's been right each time. This is not to say that it will always be right, or that the level can't get to 60 to 1 before turning. After all, no indicator is always right.

I generally watch about 50 NDX puts and 50 NDX calls throughout the day. These options are deep in the money so I can usually get an idea where the big money players are betting. These contracts are generally $50,000 to $100,000 apiece, and usually traded in lots of 250, 500 or 1000. This gives me a decent wager on the direction of the market.

When I see the NDX DWPCR stuck in neutral, I use the big money bets in the NDX as a confirmation of the trend.

For example, on January 30, 2001, I saw an order go across the tape right at the close for 500 NDX put contracts for $97,000 each. This was one of the more sizeable trades that hit the tape that day. Bought right at the close, it looked to me like smart money was expecting some downside. The SOX index had been weak and the BKX index was languishing, two other indicators that I use in my market analysis. I was already short the market, so this was a nice confirmation to me that there I was on the right side of the tape.

The last time the indicator hit 28 to 1 was on February 5, 2001, when the NDX got down to the 2409 level. The bears were pressing hard. By day's end we had snapped back over 100 points from the day's low. Being on the right side of this kind of market can mean thousands of dollars in profit per contract, even on relatively cheap NDX options.

This indicator generally leads the market move by a few hours. These technical levels don't occur very often, but when they do, in combination with your other indicators, they can provide an excellent opportunity for the short-term trader."

Chat with Fari on TradeStation.com Fari Hamzei writes for CBOE Options Hub on event-deriven basis       Futures & Options for Stock Indices
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