At The OptionWiz, we use the Put/Call ratio for individual stocks and indexes as a contrarian indicator. The Put/Call ratio can be used as a gauge of Fear or greed, which helps traders identify possible turning points.
The put/call ratio gives us the proportion between all the put options and call options purchased on any given day while gauging the overall sentiment of the market.
The ratio is arrived at by dividing the total number of traded put options by the total number of traded call options. As the ratio increases, you have more put options being purchased, indicating negative sentiment, and vice versa.
There are 2 main types of Put Call Ratios: Total Equity Put Call Ratio; and Index Put Call Ratio.
There are 2 main types of Equity Put Call Ratios; Total Equities Put Call Ratio that measures the put call ratio of all equities in the market and the Individual Equity Put Call Ratio that measures the put call ratio of an individual stock.
The most authoritative total equities put call ratio is the Chicago Board Of Exchange Total Equities Put Call Ratio. The CBOE Total Equities Put Call Ratio divides the total volume of equity put options by the total volume of equity call options traded daily and serves as the broadest measure of market sentiment in the equity market. The CBOE total equities put call ratio is also what most options traders are referring to when talking about Put Call Ratios.
Example
Today, June 13, the total market put / call volume was:
1,706,821 calls
2,188,107 puts
so, to calculate today's total put/call ratio:
2,188,107 / 1,706,821 = 1.28
A high put-to-call ratio can signal a market bottom and low number can signal a top. If the ratio falls lower than 0.3, this typically implies a sense of market euphoria; conversely, a ratio over 0.7 means that the market is now pessimistic. Therefore, at 1.28, we could definitely state that the market is very pessimistic.
To reiterate, the higher the put-call ratio, the higher the negative sentiment, tipping off a potential upward move, as the herd is usually wrong. Conversely, a low-put-call ratio suggests overt optimism, and would indicate a possible downturn.
Like any indicator, you should should not bet the farm based on a put/call ratio as it does have its issues. For one, the put/call ratio does not take into consideration whether those options are being bought or sold (buy-to-open vs. sell-to-open). This is an important distinction as when put options are sold, investor sentiment is actually bullish; and when call options are being sold, investor sentiment is actually bearish. These details are not reflected in the volume of put and call options. Thus, its difficult to know for sure whether a higher put volume is bearish or bullish.
This other issue is the put/call ratio does not take The purpose of the trade into consideration. Put and call options are bought and sold not only for individual directional trading, but also as elements of an overall stock or options strategy. So, the strategy in which the options are bought or sold determines the real sentiment of investors, which is also not taken into consideration in the put/call ratio.
You may view the daily total, index, ETF, equity, and VIX put/call ratios, on the CBOE website at http://www.cboe.com/data/mktstat.aspx
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