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. 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 >>
  3. How can a company quickly increase its liquidity ratio?

    Discover what high and low values in the liquidity ratio mean and what steps companies can take to improve liquidity ratios ... Read Answer >>
  4. How do I use ratios to perform a financial analysis?

    Learn which ratios are used in fundamental analysis. Find out how analysts measure company performance and financial health ... Read Answer >>
Related Articles
  1. Investing

    Analyze Investments Quickly With Ratios

    Make informed decisions about your investments with these easy equations.
  2. Investing

    Financial Ratios to Spot Companies Headed for Bankruptcy

    Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.
  3. Investing

    Sysco and Other Big Movers In Services

    The market has been slipping so far today. The Nasdaq has fallen 0.3%; the S&P 500 has fallen 0.4%; and the Dow has declined 0.5%. The Services sector (IYC) is currently lagging behind the overall ...
  4. 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.
  5. 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.
  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. Trading

    Three Ways to Profit Using Put Options

    A brief overview of how to profit from using put options in your portfolio.
  8. Investing

    Useful Balance Sheet Metrics

    These metrics can help you better understand the information found on balance sheets.
RELATED TERMS
  1. Put-Call Ratio

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

    The current ratio is a liquidity ratio that measures a company's ...
  3. Operating Ratio

    A ratio that shows the efficiency of a company's management by ...
  4. Variable Ratio Write

    An option strategy in which an investor holds a long position ...
  5. Policyholder Dividend Ratio

    The policyholder dividend ratio is a measurement of the profitability ...
  6. Bond Ratio

    A financial ratio that expresses the leverage of a bond issuer. ...
Hot Definitions
  1. Risk Tolerance

    The degree of variability in investment returns that an individual is willing to withstand. Risk tolerance is an important ...
  2. Donchian Channels

    A moving average indicator developed by Richard Donchian. It plots the highest high and lowest low over the last period time ...
  3. Consumer Price Index - CPI

    A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, ...
  4. Moving Average - MA

    A moving average (MA) is a widely used indicator in technical analysis that helps smooth out price action by filtering out ...
  5. Stop Order

    A stop order is an order to buy or sell a security when its price increases past a particular point in order to limit losses ...
  6. Inflation

    The rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of ...
Trading Center