What is Put Call Ratio And How to Use it

Posted by Karan Sharma on December 6th, 2022

Traders use the put-call ratio (PCR), a derivative statistic, to determine if the market is poised to become bullish or bearish. Put and call options allow holders of derivative instruments, both current and potential, to buy and sell underlying assets at fixed prices and within predetermined time frames. A put call ratio also reveals the mood of the stock market. For instance, a ratio above 1 denotes hedging attitude, whereas a ratio below 1 denotes speculative sentiment. Open interest and trade volume are the two methods used to determine the ratio.

Put-Call Ratio

Put-Call ratios are advanced indicators provided on good trading platforms of firms like IIFL Securities and ICICI. Based on trading volumes, the put-call ratio helps traders and investors decide when to trade. It takes into account the predetermined value of all open positions or the volume of options trading during a predetermined time period. Investors typically purchase more calls than puts, resulting in a PCR ratio that is typically smaller than one.

Anything between 0.7 and 1 indicates a bearish market, whereas anything between 0.5 and 0.7 indicates a bullish market.A PCR between 0.5 and 1 denotes a sideways market trend. Put and call options bought equally register a put-call ratio of 1. Ideally, PCR is influenced by the quantity of call options acquired. Keep in mind that the computation takes into account open positions for both trading operations at fixed prices and at a certain period. The put call ratio equation for open interest approach is: Total Put Options Open Interest/Total Call Options Open Interest. Similarly, based on the trading volume it is: Total Put Options/Call Options Trading Volume

Interpreting and Using Put-Call Ratios

PCR often stays close to the "1" mark. The PCR is a sign that traders are purchasing much more call options as against put options when it drops substantially below 1. That indicates a comparatively higher percentage of traders are optimistic on the stock or index. However, if the PCR rises well above 1, it means that traders are purchasing more put options over call options.So, put-call ratios show directional bets for a specific asset, and divide put options by call options. Investors consider purchasing stocks when the output is low and vice versa using the put call ratio indicator. Additionally, it aids traders in comprehending the degree of risk associated with trading assets.