Traders Section - What is the put-call ratio and what trader need to look?
What is the meaning of Put-Call ratio (PCR)?
The PCR is a popular tool specifically designed to help individual investors gauge the overall sentiment or mood of the market.
The ratio is calculated by dividing the number of traded put options by the number of traded call options for specific day.
The put/call ratio can be calculated for any individual stock, as well as for any index, or can be aggregated. While typically the trading volume is used to compute the Put-Call Ratio, it is sometimes calculated using open interest volume.
As this ratio increases, especially above 1, it can be interpreted that investors are buying more PUT options than call options. An increase in put options signals that investors are either starting to speculate that the market will move lower or starting to hedge their portfolios in case of a sell-off.
As this ratio decreases, especially below 1, it can be interpreted that investors are buying more CALL options than PUT options. An increase in CALL options signals that investors are expecting that the market will move higher.
Why should you pay attention to PCR Ratio?
The average value for the put-call ratio is not 1.00 due to the fact that equity options traders and investors almost always buy more calls than puts.
Hence, the average ratio is often far less than 1.00 (usually around 0.70) for stock options.
When the ratio is close to 1.00 or greater, it indicates a bearish sentiment.
The higher than average number indicates more puts being bought relative to calls. This means that more traders are betting against the underlying and hence the general outlook is bearish. Conversely, when the ratio is near 0.50 or lesser, it implies a bullish sentiment.
An increasing ratio is a clear indication that investors are starting to move toward instruments that gain when prices decline (that is buying PUT) rather than when they rise. Since the number of call options is found in the denominator of the ratio, a reduction in the number of traded calls will result in an increase in the value of the PCR ratio.
This is significant because the market is indicating that it is starting to dampen its bullish outlook.
Where to get put call ratio for Individual stocks and Indices?
Please visit this link to find latest put call ratio for Individual stocks and indices
How to read PCR Ratio?
Generally, a lower reading (~0.6) of the ratio reflects a bullish sentiment among investors as they buy more calls, anticipating an uptrend or bullish sign. Conversely, a higher reading (~1.02) of the ratio indicates a bearish sentiment in the market.
How to trade on Put call ratio (PCR) OR How to do put call ratio analysis?
The put-call ratio is primarily used by traders as a contrarian indicator when the values reach relatively extreme levels. This means that many traders will consider a large ratio a sign of a buying opportunity because they believe that the market holds an unjustly bearish outlook and that it will soon adjust, when those with short positions start looking for places to cover.
There is no magic number that indicates that the market has created a bottom or a top, but generally traders will anticipate this by looking for spikes in the ratio or for when the ratio reaches levels that are outside of the normal trading range.
To the contrarian investor, the put call ratio can be used to determine when the investing crowd may be getting either too bullish or too bearish. A high put call ratio is a bullish sign as the it points to an over-bearish crowd - and vice versa.
Equity put call ratio vs. Index (Nifty) put call ratio
A popular strategy used by fund managers involves the buying of index put options to protect their portfolios. As a result, the put call ratio for index options is generally higher than that for equity options. Hence, for a better indicator of the sentiment of the speculative crowd, the equity put call ratio is used instead.
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