Sentiment Analysis
Market sentiment analysis through options data provides insights into trader psychology, institutional positioning, and potential market reversals by examining put/call behavior, flow patterns, and risk appetite indicators.
Overview
Options-based sentiment analysis offers several advantages over traditional sentiment indicators:
- Real money positioning (not just surveys)
- Institutional vs retail differentiation
- Forward-looking expectations
- Quantifiable risk appetite measures
Sentiment Indicators
1. Put/Call Ratios
Volume-Based Ratios:
- Daily put volume / call volume
- 5-day, 10-day, 20-day moving averages
- Extreme readings and reversals
- Historical percentile rankings
Open Interest Ratios:
- Total put OI / call OI
- Net positioning changes
- Institutional conviction levels
- Long-term sentiment trends
Premium Ratios:
- Put premium / call premium
- Dollar-weighted sentiment
- Institutional vs retail activity
- Risk-adjusted positioning
2. Skew-Based Sentiment
Volatility Skew:
- Put vs call implied volatility
- Tail risk perception
- Fear vs greed indicators
- Risk premium analysis
Term Structure Skew:
- Near-term vs long-term skew
- Event risk perception
- Market timing indicators
- Volatility regime assessment
3. Flow-Based Sentiment
Net Flow Direction:
- Bullish vs bearish flow volume
- Institutional flow patterns
- Retail vs professional activity
- Momentum and reversal signals
Flow Toxicity:
- Informed vs uninformed flow
- Market maker adverse selection
- Price impact measurements
- Signal quality assessment
Sentiment Scoring
Composite Sentiment Score
Components:
- Put/Call Ratios (30%): Volume, OI, and premium ratios
- Volatility Skew (25%): Risk perception measures
- Flow Direction (25%): Net bullish/bearish activity
- Risk Appetite (20%): Leverage and speculation indicators
Score Range: 0-100
- 0-20: Extremely Bearish
- 20-40: Bearish
- 40-60: Neutral
- 60-80: Bullish
- 80-100: Extremely Bullish
Historical Context
Percentile Rankings:
- Current sentiment vs 1-year history
- Vs 5-year history
- Vs all-time history
- Market regime adjustments
Extreme Readings:
- 95th percentile: Extremely bullish (potential reversal)
- 5th percentile: Extremely bearish (potential reversal)
- 75-90th percentile: Strong bullish bias
- 10-25th percentile: Strong bearish bias
Sentiment Patterns
Contrarian Indicators
Extreme Optimism:
- Very high call/put ratios
- Low volatility risk premiums
- Speculative option buying
- Complacency indicators
Extreme Pessimism:
- Very high put/call ratios
- High volatility risk premiums
- Hedging demand spikes
- Fear indicators
Trend Following Indicators
Building Optimism:
- Gradually improving sentiment
- Increasing call interest
- Declining hedging demand
- Risk appetite expansion
Building Pessimism:
- Gradually declining sentiment
- Increasing put interest
- Rising hedging demand
- Risk appetite contraction
Time Frame Analysis
Short-Term Sentiment (1-5 days)
Characteristics:
- News and event driven
- High volatility in readings
- Quick reversals common
- Intraday pattern analysis
Key Patterns:
- Opening sentiment gaps
- Intraday sentiment shifts
- Event-driven spikes
- Gamma-related distortions
Medium-Term Sentiment (1-4 weeks)
Characteristics:
- More reliable trend identification
- Institutional positioning changes
- Earnings cycle impacts
- Monthly option expirations
Key Patterns:
- Expiration cycle effects
- Earnings season sentiment
- Monthly positioning shifts
- Rolling activity impacts
Long-Term Sentiment (1-6 months)
Characteristics:
- Major trend identification
- Market regime changes
- Economic cycle correlation
- Fundamental driver alignment
Key Patterns:
- Bull/bear market transitions
- Economic sentiment shifts
- Sector rotation patterns
- Long-term risk appetite
Market Condition Impact
Bull Market Sentiment
Typical Patterns:
- Generally elevated call/put ratios
- Lower volatility risk premiums
- Complacency at market tops
- “Buy the dip” mentality
Warning Signs:
- Extreme optimism readings
- Lack of hedging demand
- Speculative excess
- Sentiment exhaustion
Bear Market Sentiment
Typical Patterns:
- Elevated put/call ratios
- Higher volatility risk premiums
- Persistent hedging demand
- Fear-driven positioning
Opportunity Signs:
- Extreme pessimism readings
- Excessive hedging activity
- Capitulation signals
- Sentiment exhaustion
Sideways Market Sentiment
Typical Patterns:
- Moderate sentiment readings
- Range-bound indicators
- Mean-reverting behavior
- Lower conviction levels
Key Signals:
- Sentiment at range extremes
- Breakout confirmation signals
- Direction resolution indicators
- Volume confirmation patterns
Sentiment Divergences
Price vs Sentiment Divergence
Bullish Divergence:
- Price making lower lows
- Sentiment improving (less bearish)
- Potential bottom formation
- Reduced selling pressure
Bearish Divergence:
- Price making higher highs
- Sentiment deteriorating (less bullish)
- Potential top formation
- Reduced buying pressure
Multi-Timeframe Divergence
Short vs Long-Term:
- Different sentiment trends
- Potential inflection points
- Strategy adjustment signals
- Risk management triggers
Sector Sentiment Analysis
Technology Sentiment
Characteristics:
- Growth vs value cycles
- Innovation premium cycles
- Earnings sentiment patterns
- Regulatory sentiment impacts
Key Indicators:
- Growth stock sentiment
- FAANG option sentiment
- Innovation premium indicators
- Regulatory risk sentiment
Financial Sentiment
Characteristics:
- Interest rate sensitivity
- Credit cycle correlation
- Regulatory sentiment
- Economic outlook tied
Key Indicators:
- Rate sensitivity sentiment
- Credit spread sentiment
- Banking sector optimism
- Economic growth expectations
Defensive Sentiment
Characteristics:
- Safe haven demand
- Dividend yield chasing
- Low volatility preference
- Risk-off positioning
Key Indicators:
- Utility sector sentiment
- Consumer staple flows
- Dividend stock demand
- Volatility preference shifts
Advanced Sentiment Metrics
Sentiment Velocity
Rate of Change:
- Speed of sentiment shifts
- Acceleration/deceleration
- Momentum indicators
- Reversal timing signals
Trend Analysis:
- Sentiment trend strength
- Sustainable vs unsustainable trends
- Exhaustion indicators
- Continuation signals
Sentiment Dispersion
Cross-Sectoral Analysis:
- Sector sentiment differences
- Rotation opportunities
- Risk-on/risk-off patterns
- Leadership changes
Individual Stock Analysis:
- Stock vs sector sentiment
- Relative sentiment strength
- Idiosyncratic sentiment
- Stock selection indicators
Using Sentiment Analysis
Contrarian Strategy Applications
Entry Signals:
- Extreme sentiment readings
- Sentiment exhaustion patterns
- Historical reversal levels
- Multi-indicator confirmation
Position Sizing:
- Larger positions at extremes
- Gradual accumulation strategies
- Risk-adjusted sizing
- Diversification considerations
Trend Following Applications
Confirmation Signals:
- Sentiment trend alignment
- Building momentum patterns
- Institutional participation
- Sustainable trend indicators
Risk Management:
- Sentiment deterioration warnings
- Exit signal generation
- Position adjustment triggers
- Hedging recommendations
Sentiment and Options Strategies
High Sentiment Environments
Suitable Strategies:
- Put selling strategies
- Covered call writing
- Bull call spreads
- Low volatility strategies
Risk Considerations:
- Reversal risk at extremes
- Volatility expansion risk
- Sentiment shift speed
- Position concentration risk
Low Sentiment Environments
Suitable Strategies:
- Call buying strategies
- Protective put buying
- Bear put spreads
- High volatility strategies
Opportunity Considerations:
- Oversold reversal potential
- Volatility mean reversion
- Contrarian opportunities
- Long-term value building
Historical Performance
Sentiment Strategy Analysis
Contrarian Performance:
- Returns from extreme readings
- Hold period optimization
- Risk-adjusted performance
- Drawdown characteristics
Trend Following Performance:
- Momentum strategy results
- Trend persistence analysis
- Signal quality metrics
- Market condition dependency
Sentiment Data Sources
Real-Time Data
Options Flow:
- Live trade classification
- Institutional vs retail flows
- Size and frequency analysis
- Cross-exchange aggregation
Market Data:
- Real-time put/call ratios
- Live volatility measurements
- Intraday sentiment tracking
- News sentiment integration
Historical Data
Long-Term Trends:
- 15+ years of sentiment data
- Market cycle analysis
- Regime change identification
- Seasonal pattern analysis
Limitations and Considerations
Data Limitations
Market Structure Changes:
- Evolution of options trading
- Algorithmic trading impact
- Market maker behavior changes
- Product innovation effects
Signal Quality:
- Noise in short-term data
- Structural breaks
- Regime dependency
- Correlation instability
Interpretation Challenges
Context Dependency:
- Market condition importance
- Economic environment factors
- Geopolitical considerations
- Sector-specific factors
Signal Timing:
- Early vs late signals
- Confirmation requirements
- False signal risk
- Whipsaw potential
Best Practices
Analysis Workflow
- Multiple Timeframe Review: Check short, medium, and long-term sentiment
- Context Analysis: Consider market conditions and economic environment
- Confirmation Seeking: Use multiple sentiment indicators
- Risk Assessment: Evaluate potential for sentiment shifts
- Strategy Selection: Choose appropriate strategies for sentiment level
Common Pitfalls
Over-Reliance on Single Metrics:
- Use composite measures
- Consider multiple indicators
- Account for market context
- Maintain risk discipline
Timing Issues:
- Extreme readings can persist
- Early entry risks
- Patience requirement
- Position size management
Note: Sentiment analysis provides valuable insights into market psychology and potential reversals, but should be combined with other analytical methods and proper risk management. Market sentiment can remain irrational longer than expected, requiring patience and discipline in application.
