Put Call Ratio

What is the Put Call Ratio?

The PCR is a common technical indicator used to measure the traded volume for put options in comparison with call options. The usage of PCR facilitates the analysis of the market's sentiment and further possible movements in prices. With higher values of PCR, a bearish market arises. Low PCR or very low PCR signals the formation of a bull market. In this way, the PCR explains the amount of optimism or pessimism present in the market.

How is PCR Calculated?

PCR can be calculated in two ways:

Based on open interests of a given day
The PCR ratio is the total sum of outstanding open interest in put options for a selected security or market divided by the total of outstanding open interest in call options for that given market. Open interest is said to be the total sum of options contracts remaining unexercised and also those that did not expire.

Formula
PCR = Total open interest of put options / Total open interest of call options

Example
Assume we need to determine the put call ratio for "ABC Ltd," traded on the NSE. Total open interest for put options on ABC Ltd: 2,000 contracts. The total open interest for call options on XYZ Ltd: 5,000 contracts.
Using the formula: PCR = 2,000 (Put options) / 5,000 (Call options) = 0.4
So, the put-call ratio for ABC Ltd is 0.4.

According to the trading volume of a given day
The PCR ratio can also be derived by using the investing volume of put options and call options on a given day. This brings one nearer to getting an idea about the prevailing market mood through the trading volume that takes place during that particular day.

Formula
PCR = Total trading volume of Put options / Total trading volume of Call options

Example
Let us take the trading volume of any day of "ABC Ltd." in the BSE. The total trading volume of put options on ABC Ltd is 4,000 contracts, and the total trading volume of call options on ABC Ltd is 16,000 contracts.
By using this formula: PCR = 4,000 (Put options) / 16,000 (Call options) = 0.25
So, the PCR for ABC Ltd on that particular date is 0.25.

How to Analyse PCR (Put Call Ratio)

Here's a breakdown of PCR analysis depending on different scenarios:

• Scenario: The Nifty PCR rises as small declines are bought into an upward-rising market
  Signal: Positive
  Interpretation: It means that the upswing is expected to continue as put writers are actively engaged in writing during dips.
• Scenario: The PCR falls low as markets are gauging the levels of resistance
  Signal: Bearish
  Interpretation: It reflects that call writers are opening fresh positions expecting either a market pullback or restricted upside.
• Scenario: The PCR is dropping in a declining market
  Signal: Bearish
  Interpretation: This means that option writers are selling call option strikes aggressively.

How to Trade Using a Put-Call Ratio

The rules and guidelines for PCR trading are as follows:

• Identify Extremes: Look at the historical PCR values where the ratio reaches extreme values. Extreme peaks often mark overbought bearishness, which is typically taken back with a bullish reversal. Downside extremes may mark overbought bullishness, which is often taken back through the market pullback.
• Use the PCR in Combination with Other Indicators: Most traders prefer to use PCR technically combined with other technical indicators. They tend to combine PCR either with moving averages or with the Relative Strength Index (RSI) in order to confirm the signals arising from PCR. This happens mainly to eliminate false interpretations and enhance strong trading decisions.
• Market Context: Always look at the broader market context. If the PCR is high for an extended period of a downtrend, it may only be extending the bearish outlook. Conversely, this level of PCR in a sideways market might only suggest an oversold state.

Why is PCR Important?

PCR is one of the most significant measures that traders use when gauging market sentiment. The PCR live helps traders identify the underlying price movement of the security and guides them through placing directional bets on equities. As a contrarian signal, it helps traders avoid the pitfall of herd mentality. Another way in which the Put/call ratio is used to study overall trading activity by market players is that it measures in terms of both open interest and volume.

Advantages of Put Call Ratio

• Market Sentiment: PCR captures a snapshot of market sentiment and helps to trade towards a bullish or bearish interpretation from the market perspective.
• Contrarian Indicator: It behaves as a contrarian sign. An extremely high or low PCR may indicate the approach of mood change in the market or an upbeat or depressive attitude.
• Risk Management: Tracking PCR helps traders understand risks and make better decisions. A bearish PCR may lead to protective action, whereas a bullish PCR encourages greater risk-taking activities.
• Volatility Indicator: As many traders and investors are buying put options as some form of hedging against the negative risks that may prevail, a higher rise in PCR is generally linked with increased market volatility.
• Leading Indicator: The PCR can sometimes act as a leading indicator when extreme levels are reached.

Disadvantages of Put Call Ratio

• Subjective Interpretation: The determination of what constitutes an "extreme" level would be subjective and may vary from trader to trader.
• False Signals: As with any indicator, the PCR can produce false signals, especially if used without any other technical or fundamental analysis metrics.
• Lagging Nature: The PCR reflects previously traded option activity that doesn't necessarily translate into near-term price movement.
• Market Context Dependence: The relevance of the readings might depend on the range, trend, or reversal stage that the market finds itself in.

4 Ways to Interpret 'Nifty Put Call Ratio Live Chart' and Nifty Spot Correlation

• Trend Confirmation: A positive PCR amplified by increasing Nifty spot price would confirm that the bull trend is not over yet.
• Reversal Signal: An extremely high PCR accompanied by a falling Nifty spot price could be a hint that the market is oversold and due for a reversal.
• Bearish Divergence: When the PCR goes upwards, in contrast, the Nifty prices do not move up or go down, which indicates that more bullish sentiment turns bearish.
• Bullish Divergence: It is a situation in which the PCR goes down, but the Nifty spot price shows as steady or rising. This might reflect that bearish sentiment is dropping, and bullish momentum may start rising.

Interpretation of PCR

• PCR < 1: It suggests that more open call contracts are present than put contracts. It also means a bullish market sentiment where traders and investors believe the price of the underlying asset will rise.
• PCR > 1: If PCR is greater than 1, then the number of put contracts is higher compared to the number of call contracts, and hence, it portrays a bearish market psychology. The traders, as well as investors, think that the value of the underlying asset will go down.
• PCR = 1: When the PCR stands about 1, this usually indicates market opinion is fairly neutral since there is little crowd psychology geared toward shorting or longing, and a greater number of investors and traders have equally bullish and bearish opinions.