Put Call Ratio

Put/Call ratio (PCR) is a popular derivative indicator, specifically designed to help traders gauge the overall sentiment (mood) of the market. The ratio is calculated either on the basis of options trading volumes or on the basis of the open interest for a particular period. If the ratio is more than 1, it means that more puts have been traded during the day and if it is less than 1, it means more calls have been traded. The PCR can be calculated for the options segment as a whole, which includes individual stocks as well as indices.

Let’s see how PCR analysis can be interpreted taking option sellers into consideration who are the major players in the market as compared to the retail public who are usually on the buying side of the trade.

The interpretation of this ratio differs as per the type of investor. PCR is calculated by two methods which are as follows:

a. Based on Open Interests of a specific day

PCR is calculated by dividing the current open interest in a Put contract on a specific day by the open Call interest on the very same day.

PCR (OI) = Put open interest/Call open interest

b. Based on the volume of Options trading

Here, PCR is calculated by dividing the total Put trading volume by the total call trading volume on a specific day

PCR (Volume) = Put trading volume/Call trading volume

Put volumes are the financial market indicator for the total initiated Put option over a specific time frame. Furthermore, Call volumes are used to indicate the total initiated Call options over that period.

Put/Call ratio is an important tool used by traders to gauge the overall sentiment of the market. Put/call ratio help traders decide the price movement of an underlying security and guides them to place directional bets on the stocks. Being a contrarian indicator, it helps traders not to get trapped with Herd Mentality. As the ratio is calculated both in terms of open interest and volume, the entire trading behaviour of market participants can be analysed using the Put/call ratio.

Put/Call ratio is a derivative indicator, it looks at option build-up, helping trader gauge whether a recent rise or fall in the markets is excessive and if the time is correct to make a contrarian call. It’s an indicator that’s best made use of during market extremes, traders try to identify periods where a reversal could occur in the markets.

No such conclusions can not be drawn, interpretation depends on the market situation and historical PCR data of the Index or stock in order to take a contrarian bet

There is no fixed number, historical data needs to be compared i.e. one month or 3-month averages. PCR, like rest of the technical and derivative Indicators should be used in conjunction with the rest of the indicators and should be interpreted according to the current market scenario.

PCR as a Contrarian Indicator

The reliability of the of the indicator is quite high since it is based on the outstanding position of the traders in the market. But, when you use the indicator and how you interpret it is most important factor.