When will the stock market crash?
It’s the trillion-dollar question investors want to know.
Well, we might have an answer for you today.
Because there’s one signal that’s a big tell. One which may allow you to see the coming crash before it arrives.
First, though, let’s look at the facts.
We are in the midst of the longest recession-free period in Australia’s history. And although it can seem like we sailed through the GFC unscathed, the truth is that we spent almost our entire economic arsenal to do so.
Our economy is like an impotent battleship that’s run out of missiles but is still cruising around. Sure, we look tough. But we’re a sitting economic duck.
Now, if you were a petty officer stationed on this ship, and you wanted to know when it was time to bail, what would you do?
You might sit on deck constantly peering out at the horizon with your binoculars. But that would get tiring. You’d panic at every passing container ship in the distance. You’d lose sleep at night.
And by the time any real danger came along, you’d probably be off-guard.
Maybe you’d take the lifeboat and jump off…only to watch as the ship sails off without you safely into the distance.
Or maybe you’d sit tight with your fellow crewmen and all go down togetyher.
Either way, the simple fact is that when the next financial or market crisis hits, we’ve no ammo left.
So, you can’t rely on government spending to bail you out.
The credit card was maxed out last time and every major country — from the US to China — is sitting on mounting debts.
But there a group of people that have a 100% record in avoiding recent market crashes. Think of them like the officer class of the ship. They have better information than you. And it tells them what is happening next.
Follow the smart money
The options market is where the big boys of finance play.
No retail ‘suckers’ here.
This is the domain of the boffins, scientists, quants and hardcore traders.
Which is what makes it so fascinating to watch.
Compared to the checkers of plain-old share investing, options trading is like multi-dimensional chess.
This market actually generates probabilities around future market events. There’s no guesswork involved here. The prices feed into actual mathematical predictions of the future.
And this is good for you, if you’re smart enough to read it.
You see, there’s one indicator — the ‘smart money indicator’ — that has predicted the last 15 years of market falls.
It’s an indicator that looks at the relative amounts of puts and calls — bets on the market falling or rising. It’s called the OEX put-call ratio. And it’s simply a ratio of puts to calls on the S&P 500, which represents the top 500 companies on US exchanges.
Now, a ‘put’ is a bet on the market falling. And a ‘call’ is a bet on the market rising. The option buyer pays an upfront payment, called a premium, for the right to buy or sell at a certain price in the future.
I told you it was like multi-dimensional chess!
But, luckily, you can read it all simply enough. If you know what to look for…
Take a look at the following:
[Click to enlarge]
This is a 10-day OEX Put-Call ratio graph.
You can see that, even in the short term, rises above a ratio of 1.7 tend to indicate a short-term correction.
That’s good for the day traders, but what about major crash points?
It turns out a modified OEX indicator that uses a ratio of two can work well on longer-term charts.
Check out the following:
Source: Lyons Funds Management
[Click to enlarge]
This ratio predicted the 2000 tech crash, the 2007 GFC, and it was looking dangerously high in 2015, which you can see at the end of this chart.
Now, the market did correct after this point, but it didn’t crash hard.
A sign that perhaps the indicator is a gauge of directional timing, but perhaps not magnitude.
What I do know is that the smart money usually knows more than I do.
And there are none smarter than in the options markets.
So, whether you ever learn to trade options, knowing how they work and how to read certain key indicators can vastly help improve the timing on your own stock investments. As well as providing timely clues to major market crashes.
So, keep your eye on the OEX put-call ratio. The smart money could be trying to tell you something…
For Markets & Money
PS: Our own in-house income expert, Matt Hibbard, is an expert in options. He uses this knowledge to find smarter ways to generate income for investors. He has found a way to follow the smart money that runs the target-smashing Future Fund. Details here.