The Put Call Ratio is a significant indicator in the world of options trading. It provides valuable insights into market sentiment and can assist traders and investors in making informed decisions. In this guide, we’ll delve into all aspects of the Put Call Ratio, its importance, and how it’s calculated, helping you confidently navigate the complexities of options trading.
What is the Put Call Ratio?
To get the PCR, we divide the number of traded “put” options by the number of traded “call” options. “Put” and “call” are just types of trade in stock market. Even though the PCR is simple to calculate, it tells traders much about the trend in the market.
This number helps traders see what everyone in the market thinks and worries about.
What Does PCR Tell You?
If the PCR goes up higher than usual, it might mean that prices will go down soon because people are worried (this is called “pessimistic”). If the PCR goes down lower than usual, it might mean that prices will go up soon because people are hopeful (this is called “optimistic”).
But how do traders know what is usual or unusual for the PCR? And how can they use this number to make good trading choices?
To use the PCR well, traders need to understand the put call ratio formula and look at it carefully, considering current market conditions, past data, and possible future situations.
It’s important to remember that the PCR is helpful, but it’s not everything. Traders shouldn’t use it alone to make decisions. They should use it as one of their many tools to make smart and informed trading choices.
How is the Put Call Ratio Calculated?
The put-call ratio helps you understand what’s happening in the market. It’s a number we get when we divide one kind of option by the total of another. Specifically, we divide the number of traded put options by the number of traded call options.
The put call ratio formula is represented as:
In simple terms, if the put-call ratio exceeds 1, people might expect the market to drop. They are buying more put options because they think prices will drop.
On the other hand, if the put-call ratio is less than 1, people might expect the market to go up. So, they are buying more call options because they think prices will rise.
Based on Open Interests of a Specific Day
Let’s discuss the put-call ratio using open interests from one trading day. Open interest is how many contracts are left not settled at the end of the day.
It’s an important number that helps you understand where the market is headed. The put-call ratio, looking at open interests, gives you an idea of how the traders anticipate the market.
If the put-call ratio increases, traders might get nervous, thinking the market will drop. If the ratio goes down, traders might feel hopeful, thinking the market will increase.
But remember, looking at the PCR ratio with other market signs is important to make a good trading plan.
Based on the Volume of Options Trading
It can also be looked at through how much options are being traded. When we find the PCR ratio this way, it shows the total traded put options compared to the total traded call options.
The below table will help you understand better:
Volume of Put Options
Total number of put options traded
Volume of Call Options
Total number of call options traded
Put-Call Ratio (Volume)
Obtained by dividing the two parameters
While open interest provides a snapshot at the end of a trading day, the volume-based put call ratio can offer a more dynamic picture of trader behaviour during market hours, subsequently aiding investors in crafting their strategies with a more immediate response to market sentiments.
Analysis of Put-Call Ratio
The put-call ratio tells what’s happening in the market, especially in options trading . It’s like a tool that helps you see how traders feel about the market and where it might go.
Reading the PCR Graph
A going-up PCR graph usually means traders think the market will go down (bearish).
A going down PCR graph usually means traders think the market will go up (bullish).
Making a Plan
Traders use the put-call ratio to make trading plans, deciding how to trade based on the market’s mood.
Going Against the Flow
Some traders do the opposite of what the PCR ratio shows, thinking that a high ratio means the market will go up and a low ratio means it will go down.
Significance of the Put Call Ratio
The put call ratio, or PCR for short, gives you helpful information about how traders feel, possible changes in market trends, and how willing traders are to take risks.
It Tells You About the Market’s Mood
The put call ratio shows you the general mood of the traders. If the ratio is above 1, it usually means they think the market will fall (bearish). If it’s below 1, they usually think the market will rise (bullish).
It Shows How Much Risk Traders Will Take
The put call ratio can also show how much risk traders are willing to take. If the ratio increases, traders might be trying to protect themselves from the market going down. If the ratio decreases, traders might be more willing to take risks.
Limitations of the Put Call Ratio
Can’t Use It Alone
The PCR ratio can’t give you all the information you need about the market by itself. It’s important to use other tools and information together with it to create a full trading plan.
Affected by Outside Events
Big events or news can change what the PCR ratio shows, even if the overall trend of the market doesn’t actually change. This means that sudden changes in the ratio might not always reflect true market sentiment.
The put-call ratio provides a general overview and might not capture the specifics or detailed movements happening in particular market areas or with specific stocks.
Not Always Timely
The PCR ratio might suggest that the market will change, but that change might not happen immediately or even soon. It doesn’t always provide accurate timing for when things will happen in the market.
Put Call Ratio: A Contrarian Indicator
Sometimes, traders use the PCR differently: they look for opportunities when everybody seems really sure about the market direction.
High PCR – Might Go Up
When the PCR is high, many people think the market will go down, which we call “bearish.”
But sometimes, if everybody is too bearish, it might actually mean the market will go up soon instead!
So, a high PCR might be a secret indicator that prices will rise.
When the PCR is really low, it means a lot of people think the market will go up, which we call “bullish.”
But if everybody is too bullish, the market might surprise them and go down!
So, a low PCR might be an indicator that prices will fall.
The PCR can give traders hints about where the market might go, especially when most people think it will go one way and the other.
But remember, using the PCR smartly means checking those hints with other tools and info to make the best and safest decisions in trading.
In short, even if the PCR gives a hint, always double-check with other tools to ensure your trading moves are clever and safe!
The put-call ratio helps you see where the market might be going and when it might take a turn. However, using it carefully and with other tools is important to make a smart plan that can handle the ups and downs of trading.
So, while the put-call ratio is helpful, it should be used as part of a bigger trading plan.