The put-call ratio is a measurement that is widely used by investors to gauge the overall mood of a market.
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.
The put-call ratio is calculated by dividing the number of traded put options by the number of traded call options.
A put option gets the trader the right to sell an asset at a preset price.
A call option is a right to buy an asset at a preset price.
If traders are buying more puts than calls, it signals a rise in bearish sentiment.
If they are buying more calls than puts, watch out for a bull market ahead.
A put-call ratio of 1 indicates that the number of buyers of calls is the same as the number of buyers for puts.
However, a ratio of 1 is not an accurate starting point to measure sentiment in the market because there are normally more investors buying calls than buying puts.
So, an average put-call ratio of .7 for equities is considered a good basis for evaluating sentiment.
The put-call ratio can be an indicator of how the market views recent events or earnings.
A ratio at either extreme suggests an overly bearish or an overly bullish sentiment.
Put Call Ratio - A Contrarian Indicator
Contrarian investors use the put-call ratio to help them determine when market participants are getting overly bullish or too bearish.
An extremely high put-call ratio means the market is extremely bearish.
To a contrarian, that can be a bullish signal that indicates the market is unduly bearish and is due for a turnaround.
A high ratio can be a sign of a buying opportunity to a contrarian.
An extremely low ratio means the market is extremely bullish. A contrarian might conclude that the market is too bullish and is due for a pullback.
No single ratio can definitively indicate that the market is at its top or its n bottom.
