What is Put-Call Ratio?

PCR is the common acronym for the Put-Call Ratio.

Puts and Calls are tools for options traders to hedge their positions. It is also widely used for speculative purposes.

A call option contract gives the owner the right, but not the obligation, to buy a specified amount of an underlying security, at a specified price, within a specified time.

A put option gives the holder of the option the right, but not the obligation, to sell a specified amount of an underlying security, at a specified price, within a specified time.

The put-call ratio is an indicator used by traders to gauge the overall trend of a market.

Calculating the Put-Call Ratio

The put-call ratio is calculated by dividing the number of traded put options by the number of traded call options.

A put-call ratio of 1 indicates the number of buyers of calls and the number of buyers for puts are equal.

A ratio above 1 means there are more put buyers than call buyers and vice versa.

The total contracts of put and call can be seen in the option chain of the contract.

Indian options traders can visit https://www.nseindia.com/option-chain to check the option chain.

The table below is from the link above.

 

The Put-Call Ratio (PCR) in the example above will be 1.04 by dividing total open interest (OI) of puts (marked red) by that of calls (marked blue).

Put: 1,388,273
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Call: 1,328,881

Defining the Trend from Put Call Ratio

If traders are buying more puts than calls, it signals a rise in bearish sentiment. If they are buying more calls than puts, it suggests that they see a bull market ahead.

An average put-call ratio of 0.7 for equities is considered an oversold market while above 1.5 is considered overbought.

In the context of Indian markets, Nifty is a widely traded option and as the benchmark index, the PCR will define the market trend.

A PCR below 0.6 offers a great buying opportunity while a PCR above 1.75 is considered to be a very overbought market.

However, it is also important to look at the market based on economic parameters or black swan events like a pandemic.

It is also considered a contrarian indicator.

The change in open interest is observed by options traders to gauge the momentum of the market trend.

When the ratio is trending around 1.5-1.6, a trader will look at the market to reverse and take the position as it is in an oversold zone.

Similarly, When the ratio is trending around 0.7-0.65, a trader will look at the market to turn bearish and take the position as it is in an overbought zone.

Though the PCR may not define the tops and bottoms for the market, but the PCR can help traders make money from a dead-cat bounce or a pull-back.

Complex options strategies like straddles and strangles are traded using the put call ratio.