A:

The put-call ratio is a popular tool specifically designed to help individual investors gauge the overall sentiment (mood) of the market. The ratio is calculated by dividing the number of traded put options by the number of traded call options. As this ratio increases, it can be interpreted to mean that investors are putting their money into put options rather than call options. An increase in traded put options signals that investors are either starting to speculate that the market will move lower, or starting to hedge their portfolios in case of a sell-off.

Why should you pay attention to this? An increasing ratio is a clear indication that investors are starting to move toward instruments that gain when prices decline rather than when they rise. Since the number of call options is found in the denominator of the ratio, a reduction in the number of traded calls will result in an increase in the value of the ratio. This is significant because the market is indicating that it is starting to dampen its bullish outlook.

The put-call ratio is primarily used by traders as a contrarian indicator when the values reach relatively extreme levels. This means that many traders will consider a large ratio a sign of a buying opportunity because they believe that the market holds an unjustly bearish outlook and that it will soon adjust, when those with short positions start looking for places to cover. There is no magic number that indicates that the market has created a bottom or a top, but generally traders will anticipate this by looking for spikes in the ratio or for when the ratio reaches levels that are outside of the normal trading range.

This indicator can be created within a spreadsheet with relative ease. The data used for the calculation is available through various sources, but most traders will use the information found on the Chicago Board Options Exchange (CBOE) website.

To learn more, see Forecasting Market Direction With Put/Call Ratios.

RELATED FAQS
  1. Why is the Put-Call Ratio important for investors and economists for tracking market ...

    While short-term traders often watch the put-call ratio as a technical indicator of buyer and seller power, investors and ... Read Full Answer >>
  2. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
  3. How are double exponential moving averages applied in technical analysis?

    Double exponential moving averages (DEMAS) are commonly used in technical analysis like any other moving average indicator ... Read Full Answer >>
  4. What are the alert zones in a Fibonacci retracement?

    The most commonly used Fibonacci retracement alert levels are at 38.2% and 61.8%. A 50% retracement level is also commonly ... Read Full Answer >>
  5. How was the Fibonacci retracement developed for use in finance?

    The use of Fibonacci retracements in stock trading was popularized by noted technical analysts W.D. Gann and R.N. Elliott. ... Read Full Answer >>
  6. How reliable is the Fibonacci retracement in predicting stock behavior?

    The use of the Fibonacci retracement is subjective. There is no objective method to verify one application of the Fibonacci ... Read Full Answer >>
Related Articles
  1. Technical Indicators

    Using Moving Averages To Trade The Volatility Index (VIX)

    VIX moving averages smooth out the natural choppiness of the indicator, letting traders and market timers access reliable sentiment and volatility data.
  2. Chart Advisor

    Traders Step Back to Assess Commodities Damage

    Traders are turning to these exchange-traded notes and exchange-traded funds to analyze key commodities and determine what could be coming next.
  3. Home & Auto

    When Getting a Rent-to-Own Car Makes Sense

    If your credit is bad, rent-to-own may be a better way to purchase a car than taking out a subprime loan – or it may not be. Get out your calculator.
  4. Trading Strategies

    Are You a Trend Trader or a Swing Trader?

    Swing traders and trend traders execute market timing strategies that require different skill sets.
  5. Technical Indicators

    Detrended Price Oscillator Trading Strategies

    The detrended price oscillator (DPO) offers a simple approach to cycle analysis, removing momentum and long-term trends from the equation.
  6. Investing

    Using Fibonacci to Analyze Gold

    Use Fibonacci studies to analyze gold by picking out hidden harmonic levels that can provide major support or resistance.
  7. Options & Futures

    An Introduction To Value at Risk (VAR)

    Volatility is not the only way to measure risk. Learn about the "new science of risk management".
  8. Investing

    Looking To Begin Trading In The Stock Market?

    If you are a new trader, we explain the differences between penny stocks and options so you can make the best decision for your personal trade plan.
  9. Chart Advisor

    Real Estate Investment Trust ETFs Offer Stability

    Risk-averse traders are turning to real estate investment trusts. We'll look at a popular real estate investment trust ETF and few of its top holdings.
  10. Trading Systems & Software

    Use Price Action Trading Strategy for Results

    Bored by the fixed rules of technical and fundamental analysis? Price action trading allows you to customize your own trading strategy.
RELATED TERMS
  1. Derivative

    A security with a price that is dependent upon or derived from ...
  2. Security

    A financial instrument that represents an ownership position ...
  3. Series 6

    A securities license entitling the holder to register as a limited ...
  4. Internal Rate Of Return - IRR

    A metric used in capital budgeting measuring the profitability ...
  5. Board Of Directors - B Of D

    A group of individuals that are elected as, or elected to act ...
  6. Strike Width

    The difference between the strike price of an option and the ...

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!