The Put Call Ratio (PCR Ratio) or Call Put ratio is one of the important ratios that analyzes options markets to measure investors' sentiment and predict future pricing of the stocks. Observing the volume of put options compared to call options allows traders to ascertain whether the market is bullish or bearish.
What is the Put to Call Ratio formula?
PCR Formula:
PCR = Total Put Open Interest (or Volume) / Total Call Open Interest (or Volume)
Types of PCR
PCR (Open Interest) - Concentrates on the open options contracts and helps spot long-term moves.
PCR (Volume) - Relies on daily trading volume of options contracts and proves more accurate for short-term assessments.
Calculation of PCR
Let us take this data of ABC stock:
Put OI: 300,000 contracts
Call OI: 200,000 contracts
PCR = 300,000 / 200,000 = 1.5
A PCR of 1.5 means that there are prevailing bearish sentiment in the market.
Practical Use of PCR in Trading Strategies
1. Contrarian Approach: A subset of traders may use extreme readings (over 1.5) bearish readings to take positions expecting a market rally.
2. Trend Confirmation: Growing PCRs could confirm the existing down trend while falling PCRs confirm the up trend.
Applying PCR In Various Market Conditions
1. Bullish Market: PCR often stays below 0.7 during bullish movements.
2. Bearish Market: PCR exceeds 1.3 during bearish movements.
3. Neutral Market: PCR between 0.7 and 1.3 suggesting minimal to no directional momentum indicates a neutral market.
How to compute the put call ratio?
The PCR ratio is derived from the total open interest of put options and the total open interest of call options for a particular market or security. Open interest is the amount of options contracts that are 'alive,' meaning they have not been executed or expired.
1. About the open interests of a certain day
A specific security or market's total open put option interest is divided by the total open call option interest to calculate the PCR. If we want to find the put call ratio of “PQR Ltd” whose shares are quoted on the BSE.
The total open interest for put options on PQR Ltd is 10000 contracts.
PQR Ltd has a total open interest of call options amounting to 20,000 contracts.
PCR = Total trading volume of put options / Total trading volume of call options
PCR = 10,000 / 20,000 = 0.5
It is established that the put call ratio for PQR Ltd in this case is 0.5.
2. Based on the Trading Volume of A Day
The trading volume for put and call options within a given day can also be used to derive the PCR ratio. This approach makes it possible to gauge the prevailing market atmosphere depending on how trading is conducted within the day. Let’s take the case of “ABC Ltd” for the NSE.
https://www.finowings.com/Trading/put-call-ratio
The total trading volume of put options on ABC Ltd is 6,000 contracts.
The total trading volume of call options on ABC Ltd is 12,000 contracts.
PCR = Total trading volume of put options / Total trading volume of call options
= 6000 / 12000
= 0.5
put-call ratio is 0.5.
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