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. How is the Put-Call Ratio calculated and where does the information come from?

    Discover how major exchanges and financial websites, such as the Chicago Board of Exchange, compile data for their respective ... Read Answer >>
  2. Where can traders and investors find most recent Put-Call indicator ratios and charts?

    Learn about how the put-call ratio is calculated and interpreted, and discover where traders and analysts can obtain current ... Read Answer >>
  3. 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 ... Read Answer >>
  4. What role does ratio analysis play in valuing a company?

    Learn about the role of ratio analysis in determining company value, including some of the most common ratios used by modern ... Read Answer >>
Related Articles
  1. Investing

    What is Put-Call Parity?

    Put-call parity describes the relationship that must exist between European put and call options with the same expiration date and strike prices.
  2. Trading

    Leading Indicators Of Behavioral Finance

    Discover how put-call ratios and moving averages can be used to analyze investor behavior.
  3. Investing

    The Price To Earnings Ratio Explained

    The price to earnings ratio is one of the most important ratios in investing. Find out how it is calculated, how it can be used and what it tells investors about a particular stock.
  4. Investing

    4 Simple Investing Ratios You Need To Know

    Dissecting a company’s financial statements to uncover ways to make money is a challenging endeavor. Here are four ratios that can help.
  5. Investing

    SXC Health Solutions Corp. (USA) Among the Nasdaq's Biggest Movers

    The market is having a bad day so far: the Nasdaq is trading down 0.3%; the S&P 500 has declined 0.4%; and the Dow has slipped 0.5%. The Nasdaq Composite Index is a capitalization-weighted index, ...
  6. Investing

    5 Must-Have Metrics for Value Investors

    These quick-and-dirty ratios will help you find the most undervalued stocks on the market.
  7. Investing

    Payout Ratio vs. Retention Ratio: When to Use Which

    The payback ratio and retention ratio collect different information and are useful in different situations.
  8. Investing

    Do Your Investments Have Short-Term Health?

    If a company is strong enough to survive tough times, it is more likely to provide long-term value.
RELATED TERMS
  1. Put-Call Ratio

    The put-call ratio is the ratio of the trading volume of put ...
  2. Ratio Spread

    An options strategy in which an investor simultaneously holds ...
  3. Key Ratio

    A mathematical ratio that illustrates and summarizes the current ...
  4. Operating Ratio

    A ratio that shows the efficiency of a company's management by ...
  5. Policyholder Dividend Ratio

    The policyholder dividend ratio is a measurement of the profitability ...
  6. Capitalization Ratios

    Indicators that measure the proportion of debt in a company’s ...
Hot Definitions
  1. Liquid Asset

    An asset that can be converted into cash quickly and with minimal impact to the price received. Liquid assets are generally ...
  2. Nostro Account

    A bank account held in a foreign country by a domestic bank, denominated in the currency of that country. Nostro accounts ...
  3. Retirement Planning

    Retirement planning is the process of determining retirement income goals and the actions and decisions necessary to achieve ...
  4. Drawdown

    The peak-to-trough decline during a specific record period of an investment, fund or commodity. A drawdown is usually quoted ...
  5. Inverse Transaction

    A transaction that can cancel out a forward contract that has the same value date.
  6. Redemption

    The return of an investor's principal in a fixed income security, such as a preferred stock or bond; or the sale of units ...
Trading Center