The Put-Call Ratio is the number of put options traded divided by the number of call options traded in a given period.
While typically the trading volume is used to compute the Put-Call Ratio, it is sometimes calculated using open interest volume or total dollar value instead. Weekly or monthly figures can also be calculated and moving averages are often used to smooth out the short term daily figures.
How to interpret the put call 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.
The put call ratio as a contrarian indicator.
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 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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