Put Call Ratio is the ratio of the amount of put options traded versus the amount of call options traded.
Put Call Ratio is one of the two indicators directly derived from options trading, the other one being the VIX. Put Call Ratio is used by options traders around the world as a contrarian indicator of market sentiment. As an indicator of market sentiment, Put Call Ratio tells you when investors are in a bullish or bearish mood. Put Call Ratio is arrived at by dividing the total amount of put options traded by the total amount of call options traded. There are many types of Put Call Ratios and many ways to interpret it and we shall go through all of them in this tutorial.
Here is the simple formula for calculating Put Call Ratios:
Volume Of Put Options / Volume Of Call Options
There are 2 main types of Put Call Ratios; Total Equity Put Call Ratio, Index Put Call Ratio.
Equity Put Call Ratios measure the put call ratio of
equity based options such as
stock options
while Index Put Call Ratios measure the put call ratio of index based options such as the OEX.
There are 2 main types of Equity Put Call Ratios; Total Equities Put Call Ratio that measures the put call ratio of all equities in the
market and Individual Equity Put Call Ratio that measures the put call ratio of an individual stock.
You can get the daily CBOE Total Equities Put Call Ratio along with a 5 days graph at our Option Trader HQ. |
Index Put Call Ratios, also known as Composite Put Call Ratios, are put call ratios calculated for component stocks in an index such as the OEX.
Index put call ratios are meant to be contrarian indicators for the underlying index but
due to the amount of
hedging done by
portfolio managers and
Market Makers in the index options resulting
in a skew towards more
put option buying than
call option buying, Index Put Call Options are not
generally regarded by the options trading community as indicative of general investor sentiment.
Put Call Ratios also come in various time scales. In fact, the CBOE Total Equities Put Call Ratio comes with daily, weekly as well as monthly
ratios.
There are 2 main ways to interpret the Put Call Ratio. First, it is taken widely to be a "Panic Meter" where a higher reading suggests panic
in the market as investors rush into put options. Second, it is taken to be a contrarian indicator which points to major reversals in the market.
There are 2 main problems associated with Put Call Ratios:
1. Does not differentiate between buying or writing volume
2. Does not take the purpose of the trade into consideration
The main drawback of the Put Call Ratio is that it does not take into consideration whether those options are being bought or written. In layman terms, options volume does not differentiate if a trade is a "Buy To Open" or "Sell To Open" trade. When put options are being written, investor sentiment is actually bullish instead of bearish and when call options are being written, investor sentiment is actually bearish but such information are not reflected in the volume of put and call options. This makes it hard to prove emphirically whether a higher put volume is bearish or bullish.
Both call options and put options are bought and sold not only for speculative directional trading but also as components in an overall stock or options strategy. Call options can be sold in Covered Call strategies in order to speculate a stagnant market and put options can be bought to protect a portfolio of stocks expected to move to upside in a Married Put. The strategy within which the options are bought or sold determines the real sentiment of investors and that is not taken into consideration in the Put Call Ratio as well.
:: Does Options Volume Predict Stock Direction?
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