What is Put Call Ratio & How to Use it for Options Trading?

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In trading, there are various indicators you can use to gauge the market sentiment and the likely trend that helps the traders make the right decision for trading. And trading in options you need to be very cautious to get the right indication of the market to enter into the right trading strategy.

As much as the trading activities in call and put increases or decreases, the option premium prices also get affected. Hence you can use the trading activities in the call and put to get an indication of the market or identify the trend in particular underlying security. However, to use this as an indicator in trading you have to understand the put-call ratio.

What is Put Call Ratio?

The put-call ratio (PCR) is simply the ratio of the volume of puts over the calls for a specific time. And here volume means the volume of open interest in the call option and put option. The put-call ratio is measured against the value 1, if the PCR is more than 1 it means the put volume is higher than the call volume, while if the PCR is less than 1 it indicates the call volume is higher than the put volume.

What is Put put-call ratio in Options?

In options, the volume of trade is considered through the open interest that is built up in the market index or in specific underlying security trading in the options.When traders buy, more call options compared to the put option the PCR remains below 1.

On the other hand, when traders buy more put options compared to call options, the PCR will remain above 1. And if PCR is equal to 1, it means the open interest in the call and put option is the same. The PCR ratio gives a certain indication of the market or the underlying security. Based on the indication you can make the right trade decision in options trading.

What Does Put Call Ratio Indicate?

The PCR shows the trading volume or open interest in the call and put, and the value of the PCR indicates the types of trends or sentiments of the traders towards the market or the underlying security. When PCR is above 1, it indicates there is bearish sentiment in the market, while a PCR with a value below 1 gives the indication of a bullish trend in the market.

And when the PCR is equal to 1, it means the market trend is neutral or there is no clear trend or sentiment visible in the market. An extremely low or high put-call ratio meansmarket participants are getting overly bullish or too bearish. Interpreting and analysing the PCR precisely will help you to make the best use of this indicator in option trading.

How to Interpret PCR Ratio?

To interpret the PCR ratio you need to understand more about call put and open interest that is generated during the trades. The PCR is calculated by dividing the number of traded put options by the number of traded call options. The traded quantity here refers to a number of contracts that shows the total open interest in the traded contracts.

The put-call ratio provides insights into the market sentiment with the potential for future price movement of the market or the underlying security. When PCR is less than 1, it means the open call contracts are more than put contracts which shows the market sentiment is bullish means the underlying security is likely to rise in the near future.

On the other hand, when PCR is more than 1, it indicates the open put contracts are more than the call contract. This means that the market sentiment is bearish, which means that the market index or price of the underlying security is likely to fall in the near future.

However, when the PCR is equal to 1, it means the open interest contract in call and put are almost the same and the market sentiment is balanced. Here the market trend is unclear or you can neither its bullish nor bearish with undefined movement. Overall, you can interpret the PCR ratio to know the sentiment of the traders in the options market.

How to Analyse PCR Ratio?

When put call ratio increases but the minor dips getting bought during the uptrend market, it gives the bullish indication. This is the indication that put sellers are aggressively selling at dips expecting the continuation of an uptrend in the market.

On the other hand, put put-call ratio decreases at the market is resisting at the resistance level which gives a bearish indication. It also shows that call sellers are creating new positions in the market with the expectation of correction or limited upside in the market.

However, if the put call ratio decreases when the market is down-trending, it’s also an indication of bearish sentiment. This shows the option sellers are aggressively selling the call option strikes and expecting an upside in the market trend.

What is a Good Put Call Ratio?

The put call ratio greater than or lower than 1 shows the bearish or bullish sentiment of the market. But the question right there is how much put call ratio is good. The PCR is not fixed and can vary as per the market trend with the change in the sentiment of the traders.

However, as per the market experts, the PCR value of 0.7 is considered a good put-call ratio. While the PCR value higher than 0.7 or more than 1, suggests a bearish sentiment is generating in the market. When the PCR value goes below 0.7 and falls close to 0.5, it means the buying activity in the calls is higher than the puts, indicating the bullish sentiment in the market.

How to Use Put Call Ratio in Options Trading?

One of the main motives for using and analysing any indicator or technical tool in the stock market is how to make the best use of such indicators in trading. The PCR can be calculated from the data gathered in the option market, while the result of the ratio can be used for trading in the cash market or in the future and option market to trade with the right trading strategy.

To use the PCR in trading or in option trading you have to interpret and analyse the PCR data in coordination with market movement. When you get an idea of market sentiment and the expected movement of the market, you can enter into the right trade position.

Using the put-call ratio, you can use this indicator to identify the sentiments with the potential of overbought and oversold status of the market. When PCR reaches the peak levels, and combination of another signal while analysing the price action, enters and exits into the trade positions. Similarly, there are various conditions you can use PCR for trading strategies.

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