The definition: The put-call ratio is a technical analysis indicator that measures the number of put options traded relative to the number of call options traded. It is used to gauge investor sentiment and measure the market’s expectation for future stock price movement.

A high put-call ratio typically indicates that investors are bearish on a stock, while a low put-call ratio typically indicates that investors are bullish on a stock. The put-call ratio can also be used to identify overbought or oversold conditions in the market.

The put-call ratio should be used in conjunction with other technical indicators to help you form an accurate picture of how the market is feeling about a particular stock.

Things to consider

The put-call ratio is a measurement of market sentiment that investors use to predict whether the market will go up or down. However, it’s crucial to consider both the numerator (puts) and denominator (calls).

In the denominator of the ratio, the number of call options is found. As a result, a reduction in the number of traded calls will boost the ratio’s value. This is significant because selling fewer calls can increase the ratio without necessitating an extra purchase of puts. To put it another way, we don’t need to see a large number of puts bought in order for the ratio to rise.

The result is that there are more bearish traders in the market when bullish traders sit on the sidelines. It doesn’t necessarily imply that the market is bearish; rather, it indicates that bullish traders are in a waiting mode until an event like an election, a Fed meeting, or economic data release occurs.

Contrarian indicator for contrarian investors

The put-call ratio is used by contrarian investors to determine when market players are becoming excessively optimistic or pessimistic.

A put-call ratio of 100 percent or more indicates a highly bearish market. A contrary might regard a high put-call ratio as a bullish indication that the market is overly bearish and set to change. A high ratio can be seen by a contrarian as providing an opportunity for buying.

A ratio of 0 indicates that the market is extremely bullish. A contrarian may believe that the market is too optimistic and will soon collapse.

The single put-to-call ratio cannot always reveal whether or not the market is at its top or bottom. Even the put-to-call ratios that are deemed extreme change over time.

Typically, investors compare current ratio values to the typical average over some time period to see whether sentiment has changed. Traders may interpret a put-call ratio that fluctuates in a tight range and then rises dramatically as a sign of growing bearish sentiment, which might trigger their actions accordingly.

The formula for Put-Call Ratio

Put Call Ratio = Put Volume / Call Volume

Put volume: The number of put options purchased over a specific time period

Call volume: The number of call options purchased over a specific time period

How to Read the Put-Call Ratio

A PCR of less than one (less than 1) indicates that investors are buying more call options than put options, suggesting a bullish trend ahead.

A PCR of more than one (1) indicates that traders are buying more put options than call options, suggesting that they are speculating a bearish trend.

The increasing number of put options issued by investors suggests that they are buying the same amount of call options as put options, which is a neutral trend in the long run.

A PCR of 0.7 or higher is regarded as desirable, but a PCR of 0.7 or lower is considered strong bullish sentiment, and a PCR of more than 1 is considered strong bearish sentiment.

What’s your investment style?

The PCR is interpreted differently according to the investor’s investment style. Consider two investment types:

One PCR may be taken as a bullish signal by a contrarian investor, while another PCR might be seen as a bearish indication by a bearish investor.

A high PCR may be interpreted as a bearish signal by a momentum investor, but it could also be interpreted as a bullish signal by a value investor.

As a result, the PCR is dependent on the investor’s investment style, and as such, there is no one correct way to interpret it.

Where to find Put-Call Ratio online

The cboe.com website is a well-known location where you can look up the put-call ratio in the market. The PCR for a number of indexes and products is provided by Cboe. On July 12, 2019, the index PCR was 1.15, with the exchange-traded funds PCR at 1.32.