This is one ratio which is picked up from the equity futures and options (F&O) market to guide investment and trading strategies in the equity cash market.
How is it arrived at
The Put-Call Ratio brings out how many Put OPTION contracts got traded for every Call contract that was traded on any given trading day on a particular index or stock. The Put-Call Ratio is simply the number of Put trades divided by the number of Call trades.
For instance, on May 14, 2015, a total of 74.24 lakh Index options contracts got traded on the NSE. This was made up of 34.11 lakh Index Put trades and 40.13 lakh Index Call trades. On that day, therefore, the Put-Call Ratio was 0.85. For every 100 Index Call contracts traded on that day there were 85 Index Put contracts which got traded.
What is it used for
Traders and investors track the Put-Call Ratio to get a rough sense of the upcoming trend in the underlying stock or index.
A Put-Call Ratio of above One simply means more Puts getting traded than Calls.
Puts generally imply a bearish outlook and so when they are getting traded more than Call contracts a general impression of bearishness overwhelming bullishness is created.
Thus, if an index or a stock is consistently seeing a Put-Call Ratio of more than One it would broadly imply a bearish trend.
Why Puts are bearish and Calls are bullish
Buyer of a Put contract gets the right, but not the obligation, to sell an index or stock while the Seller is obliged to buy the index or stock if the Buyer exercises his right. Therefore, when an investor or trader expects the price of an index or stock to fall he would buy a Put contract.
The opposite is true for Call contracts. Buyer of a Call contract gets the right, but not the obligation, to buy an index or stock while the Seller is obliged to sell the index or stock if the Buyer exercises his right. Therefore, when an investor or trader expects the price of an index or stock to rise he would buy a Call contract.
Why that may not always be so
Puts can also be bought by investors who are bullish but who are performing complex trading strategies simultaneously involving cash market positions and trades in futures and options. Similary, Call Buyers could be bearish investors deploying complex trading strategies.
Thus, it may not always be case that a Put-Call Ratio of more than One points to bears overwhelming bulls. Conversely, a Put-Call Ratio of less than One will not always denote bulls overwhelming bears.
Don't miss another Article
Subscribe to our blog for free and get regular updates right into your inbox.