What is the put-call ratio and why should I pay attention to it?

By Casey Murphy AAA
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 ...

    Discover why the put-call ratio is considered a useful measure for investors and economists when they are determining market ...
  2. Where can I find out about upcoming stock splits?

    Learn what a stock split is, how it is accounted for and where to find upcoming information about stock splits on the Internet.
  3. Does the buyer or the seller control a call option?

    Buy call options and maintain control over the price you pay and when to buy a given stock. Learn how to maintain control ...
  4. Which market indicators reflect volatility in the stock market?

    Learn the most commonly used technical indicators of stock market volatility that are watched by stock market traders and ...
RELATED TERMS
  1. Catastrophe Equity Put (CatEPut)

    Catastrophe equity puts are used to ensure that insurance companies ...
  2. Open Trade Equity (OTE)

    Open trade equity (OTE) is the equity in an open futures contract.
  3. Indicator

    Indicators are statistics used to measure current conditions ...
  4. Intraday Momentum Index (IMI)

    A technical indicator that combines aspects of candlestick analysis ...
  5. Multibank Holding Company

    A company that owns or controls two or more banks. Mutlibank ...
  6. Short Put

    A type of strategy regarding a put option, which is a contract ...

You May Also Like

Related Articles
  1. Active Trading Fundamentals

    Why is the Put-Call Ratio important ...

  2. Options & Futures

    Trade Covered Calls On High Dividend ...

  3. Mutual Funds & ETFs

    How do I invest or trade market indicators?

  4. Options & Futures

    Trading Volatility? Don’t Trade Stocks, ...

  5. Trading Strategies

    Look At The Whole Picture To Manage ...

Trading Center