As the name suggests, it is the ratio of the puts to the calls but let’s look in detail. Finding Put Call Ratio for a stock and understanding the concept of Put Call Ratio options is very important. It is also necessary to read Put Call Ratio charts as the shifts are essential indicators of the likely market movement. Most traders use the Put-Call Ratio as a relatively reliable indicator of the market’s direction.
What is Put Call Ratio?
Put Call Ratio measures the ratio of the put open interest on a given day to the call option open interest on the same day. The Put-call ratio is a measurement commonly used by investors to gauge the overall mood of a market. A put option gives you the right to sell an asset at a specific price. Conversely, a call option is a right to buy an asset at a fixed price.
If traders are buying more puts than calls, it signals a rise in bearish sentiment. If they buy more calls than put, it suggests that they see a bull market. Call options are usually bought in a bullish market. By studying the Put-call ratio, the investors can anticipate the market’s overall sentiment.
Understanding the Put-call Ratio
Divide the number of traded put options by the number of traded call options to get the put-call ratio. A put-call ratio means that the number of call buyers equals the number of put buyers. On the other hand, a ratio of one is not a realistic starting point for measuring market mood because investors often buy more calls than puts. As a result, an average put-call ratio of.7 for stocks can be a decent starting point for assessing mood.
How to Calculate the Put-Call Ratio?
To calculate the Put-Call Ratio, you need to divide Puts’ total open interest (OI) by the total open interest of Calls. The calculated value usually ranges from 0.5 to 1.50
PCR = Traded Volume of Puts/Traded Volume of Calls
PCR= Open Interest of Puts/ Open Interest of Calls
For example, if the total open interest in Calls and Puts on September 1st is 100,000 and 80,000, respectively, then.
Put-Call Ratio = 8,000/10,000 = 0.8
How to Analyze and Interpret Put Call Ratio?
- When the Put call ratio is more than one, it indicates that more puts are being purchased in the market than calls. It indicates that the market has a negative attitude.
- When an extremely high number above 1 indicates that the market is oversold and at that point, there could be a reversal, and one can expect the market to go up.
- If the put-call ratio is less than one, it indicates that more calls are being purchased in the market than puts. It indicates that market sentiment is positive.
- Usually, when a deficient number above 1 indicates that the market is overbought, and at that point, there could be a reversal, and one can expect the market to go down.
- The market is neutral when the Put-Call Ratio value lies between 0.9 and 1.1
It is an overarching understanding of PCR. The extreme PCR values for various indices and stocks vary, and plotting daily PCR historically can assist in detecting these extreme levels. For example, a Put Call Ratio of 1.4 for the Nifty may suggest strong bearishness, yet a Put Call Ratio of 1.2 for Reliance may not be adequate to imply the same.
Put Call Ratio is a Contrarian Indicator
The Put-call Ratio is generally used by traders as a contrarian indicator when the values reach relatively high. It means that many traders may view a high Put Call Ratio as a buying opportunity if they feel the market mood is particularly pessimistic and will shortly adjust.
However, the Put-Call Ratio is not a magic figure that tells whether the market has reached a bottom or a peak. However, in general, traders would watch for spikes in the Put-Call ratio or when the ratio hits levels outside of the regular trading range to predict the market top or bottom. The primary trend of the NIFTY Put call ratio appears to vary between 0.8 and 1.3, with 0.8 being the lower band and 1.3 representing the higher band.
Special Considerations
The put-call ratio assists investors in gauging market sentiment before a market change. HoweFirst, however, it is critical to consider the demand for the numerator (the puts) and the denominator (the calls). The ratio’s denominator contains the number of call choices. A decrease in the quantity of traded calls raises the ratio’s value. It is crucial because fewer calls purchased can raise the ratio without increasing the number of puts purchased.
As optimistic traders remain on the sidelines, more pessimistic traders enter the market by default. It does not necessarily imply that the market is bearish, but rather that bullish traders are waiting for an approaching event, such as an election, a Fed meeting, or the publication of economic data. Such investors look for best low price shares to buy today to turn make a good profit tomorrow.
It’s helpful to keep an eye on the put-call ratio to observe how the market perceives recent events or earnings. When the ratio reaches extreme levels, it may imply an excessively pessimistic or excessively bullish mood.
As a result, some investors regard the put-call ratio as a contrarian indication.
