Understanding the put-call ratio
The put-call ratio is considered to be one of the most reliable indicators of the market direction.
The Put-Call Ratio simply takes the number of put options traded and divides it by the number of call options.
The put-call ratio is a popular derivative indicator, particularly thought up for traders as an indicator to understand the behaviour of the market. This indicator helps understand the extent of the bullish or bearish trends in the market.
Most traders use PCR as a fairly reliable indicator of the direction of the market.
How can you find “Put-Call ratio today?”
Nifty PCR measures how many put options contracts are open versus call options contracts in the Nifty Option Chain.
To find the Put-call ratio for a particular day, you can visit the NSE site and read the Nifty Option Chain and derive the PCR at any given day for any given options.
The put-call ratio is calculated on the basis of options trading volumes or the open interest.
Open interest in options is the value of all positions that are open in the market. While OI represents the stock, volumes represent the flow in the market. While both are used, the PCR (OI) is normally the stronger indicator of trends in the market and the PCR (Volumes) is normally used to validate the conclusions that we get with Open Interest of PCR.
PCR can only be relevant for stocks that are available for trading on the F&O market.
The put-call ratio can be calculated by dividing the total number of open interest in a Put contract by the number of open interest in the Call option at the same strike price and expiry date on any given day.
PCR (OI) = Put open interest/ Call open interest
Options Trading Volumes
The put-call ratio is calculated by dividing the number of traded put options by the number of traded call options.
PCR (Volume) = Put trading volume/Call trading volume
PCR Direction/ Movement
PCR goes higher when the total Open Interest (OI) of Puts are higher than the total OI of Calls.
PCR moves down when the total OI of Puts are lower than the total OI of Calls.
If the ratio is more than 1, it means that more puts have been traded during the day and if it is less than 1, it means more calls have been traded.
The higher is the PCR number, the more negative the directional bias is for that asset. E.g. if a PCR shows 2.5, then this means that there have 2.5 times more interest input options than calls.
What is a good Put-Call Ratio?
An average put-call ratio of (.7 to 1) for equities is deemed as a good basis for evaluating sentiment.
What is a bad Put-Call Ratio?
A negative P/E ratio means the company has negative earnings or is losing money. ... However, companies that consistently show a negative P/E ratio are not generating sufficient profit and run the risk of bankruptcy.
How can you interpret PCR analysis by taking the majority of traders in the market into consideration, i.e. option sellers.
Again in this case also, the trend of PCR (OI) movement is more critical than the absolute numbers. One can also calculate the PCR based on incremental OI to get a clearer picture.
Importance of Put-call Ratio
PCR helps you determine the market sentiment effectively at any given time.
PCR helps traders know what direction is the price of underlying securities moving.
It helps traders to avoid the herd mentality as per behavioural finance when it comes to investing in the market.
PCR has proven useful in monitoring the overall trading behaviour of the market participants.
Notwithstanding, PCR as a derivative indicator has its own share of drawbacks. Investors must find these limitations out while planning to invest in the market based on PCR.
Limitations of Put-call Ratio
One of the biggest limitations of PCR is that it does not always indicate the critical differences of market sentiments.
Since all company stocks don’t make options available so it becomes impossible to compute the PCR for those stocks.
Even though it is an indicator contrary to popular opinion, investors must consider the other important factors before betting on the existing market sentiments.
As mentioned earlier, PCR cannot be reliable completely, so to achieve effective outcomes, one must use PCR as an additional indicator to other indicators.
Analysing PCR also demands the investors to know how to read the put-call ratio chart correctly; as even a small shift proves as an essential indicator of the market movement.
“In any case, it is advisable for investors to keep knowledge of how to find PCR and make the most of it. This is important to make an informed and secured decision. Investors must be aware of their risk-taking capability and investment goal before they decide to step into the market as Calculating PCR based on sudden expressions of the market in volumes can be misleading and lead you to wrong conclusions. “