There are various ways to find an asset’s future market trends and sentiments. One way to do this is to use the put-call ratio. It helps traders find whether the future of their particular asset would be positive or negative. In this article, we will cover what this ratio is and how to use it to your advantage.

Definition of the Put-Call Ratio

The put-call ratio is simply a mechanism to understand how traders are feeling about a stock or the future of the market. The put-call ratio can be computed by dividing the aggregate open interest of outstanding put options by the aggregate open interest of outstanding call options for a given security or market.

A high put-call ratio — above 1 — is a bearish sentiment, suggesting that traders purchase put options relatively higher than call options, probably on the assumption of a decline in the market.

On the other hand, a low put-call ratio—below 1—indicates a bullish sentiment and means that a higher number of call options are preferred than put options, probably on assumptions of a pending rise in the market.

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How to Calculate the Put-Call Ratio

Now, let’s see how you can calculate this ratio.

The formula for calculating the Put-Call Ratio is:

Put-Call Ratio (PCR)=Number of Call Options Traded / Number of Put Options Traded

Here,

• Number of Put Options Traded: The total number of put options that have been bought or sold.
• Number of Call Options Traded: The total number of call options that have been bought or sold.

Interpretation

A PCR >1 shows that the put volume has crossed the call volume. This rise in the value means an increase in bearish sentiment.

A PCR<1 shows that the volume of the calls is more than that of the puts. It is indicative of a bull market ahead.

The Put-Call Ratio is often used by traders as a contrarian indicator, meaning a very high PCR might suggest that the market is oversold (too bearish), while a very low PCR might suggest that the market is overbought (too bullish).

Let’s take a simple example,

Mr. Kumar is a trader who wants to check the market sentiment for a particular security using the put-call ratio. He sees that:

Put-Call Ratio (PCR) = Number of Call Options Traded / Number of Put Options Traded.

= 1300/1700
= 0.7647

Since the value is less than 1, it just interprets that more call options are purchased by traders in comparison with put options.

Conclusion

Put call ratio is quite useful for finding market sentiments over a stock or overall market. However, this ratio should be used with other indicators to make an informed decision. To learn more about it, traders can enroll in option trading full course from Upsurge.club. Upsurge.club offers a wide range of online courses to help beginners learn market concepts.

Author: Manali
Manali is a professional writer for Quertime.com.

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