The put-call ratio is the number of put options traded divided by the number of call options traded in a given period; this ratio is used to gauge the overall sentiment in the market.
This article will explain everything needed to know about the put-call ratio and how it is used. The put-call ratio is important because it gives investors an idea as to whether the market is currently bearish or bullish.
A put option is a contract that gives the buyer the right, but not the obligation, to sell a security at a certain price by an expiration date. A put option is bought when an investor expects the price of the security to go down.
A call option is a contract that gives the buyer the right, but not the obligation, to buy a security at a certain price by an expiration date. A call option is bought when an investor expects the price of the security to go up.
If investors want to learn specifically about puts and calls, then click here.
A put-call ratio of 1 indicates that the number of buyers of puts is the same as the number of buyers of calls. However, a ratio of 1 is not the best starting point to measure the sentiment in the market because more investors buy calls rather than puts. Therefore, a put-call ratio of .7 is a good starting point to measure sentiment in the market.
If the ratio rises above .7, then that means more people are buying puts rather than calls. This is an indication of a bearish market because more investors are expecting the market price of the underlying security to fall.
If the ratio falls below .7, then that means more people are buying calls rather than puts. This is an indication of a bullish market as more investors are expecting the market price to rise.
The put-call ratio can be viewed from a contrarian perspective. If the ratio is above .7, then to a contrarian investor, this would be a good time to buy as the market price of the underlying security could be lower than expected. If the ratio is below .7, then this would be a good time to sell as the market price could be higher than expected.
However, what an investor does with the put-call ratio is entirely up to their own personal investment strategy. The key take-away from this article is that the put-call ratio is a useful tool that can be used to gauge whether the market is going up or down.
