In this article, you will learn what is the Put/Call Ratio. While most options traders are familiar with the leverage and flexibility options offer, not everyone is aware of their value as predictive tools. Investors in the stock market apply different kinds of financial tools to gauge the stock market mood before putting their funds in any of the securities. The put call ratio (PCR) is one such crucial technical indicator which intends to reflect the sentiment of the stock market and indicates the future market direction.
What is the Put/Call Ratio?
The Put/Call Ratio (PCR) is an indicator that plots put volume divided by call volume. Put options give the owner the right to sell a certain amount of an underlying security at a fixed price within a specified time frame. They can be used if you expect a decline. Call options give the owner the right to buy a certain amount of an underlying security at a fixed price within a specified time frame. They can be used if you expect an advance. If the PCR value is higher than 1 . this means put volume is higher than call volume.
If the PCR value is lower than 1. this means call volume is higher than put volume. Traders can use the indicator to determine market sentiment because it gives information about the overall expectations of a decline or an advance. Some traders apply a moving average to smooth the data, to generate signals or to facilitate the discovery of trends. There are several ways to use PCR in a trading strategy and most traders use the indicator in combination with other analysis techniques.
Interpretation of Put/Call Ratio
It is to be noted that put options help the traders to hedge when the market is weak and take chances on the market decline. Whereas, the call options are used to hedge against the strong cues of the market and give holders the right to buy a particular stock with the expectation of a possible rise in the price.
The PCR is not just calculated for individual stocks, it can be calculated for indices, stocks and for the derivative segment as a whole.
-Put Call Ratio As A Contrarian Indicator
PCR is also considered as a contrarian indicator which helps traders not to get caught in the herd mood of the market. Based on the extreme PCR ratio, the trader might take a call to buy or sell against the prevailing mood of the market.
For example, when the PCR is at a very high level, it sends out the signal of extremely bearish market sentiment. This also signs that the market may soon bottom out and might show some upward trend . Whereas, when the put call ratio falls to A very low level, it sends out the signal of an extreme bullish market, which also suggests that a market is too bullish and can show some pullback sign.
Bottom Line
As with any indicators, they work best when you get to know them and track them yourself. They should thus be included in any market technician's analytical toolbox. This is about what is the Put/Call Ratio.
