Put Call Ratio

Put/Call ratio (PCR) is a popular derivative indicator, specifically designed to help traders gauge the overall sentiment (mood) of the market. The ratio is calculated either on the basis of options trading volumes or on the basis of the open interest for a particular period. If the ratio is more than 1, it means that more puts have been traded during the day and if it is less than 1, it means more calls have been traded. The PCR can be calculated for the options segment as a whole, which includes individual stocks as well as indices.

Understanding PCR (Volume) and PCR (OI) with illustrations

The calculation of PCR for volumes and for open interest is quite simple. Remember, PCR is also calculated with respect to a specific strike. Let us look at PCR of volumes first.

Assume that the put volumes in the Nifty 10,700 strike is 85,000 contracts and the call volumes in the same contract for the same expiry is 1, 28,000 contracts. In that case,

PCR (Volume) = 85,000 / 128,000 = 0.66

More than the PCR at a point of time, it is the trend of PCR over a period of time that is a more reliable indicator. Let us also look at PCR of open interest…

Assume that the open interest of puts the Nifty 10,700 strike is 38, 00,000 contracts and the open interest of calls for the same contract and expiry is 49, 00,000 contracts. In that case,

PCR (OI) = 38, 00,000 / 49, 00,000 = 0.78

Again in this case also, the trend of PCR (OI) movement is more critical than the absolute numbers. One can also calculate the PCR based on incremental OI to get a clearer picture.

Formula for the Put-Call Ratio

Put Call Ratio=

Put Volume/Call Volume

Put Call Ratio

Where-

• Put Volume is the number of put options initiated over a determined time period; and

• Call Volume is the number of call options initiated over the same time period.

It is important to note that the PCR is not limited to put volume and call volume in its calculation. It is common for investors to use a variation, as shown below:

 Put Call Ratio= Total Put Open Interest/Total Call Open Interest

Put-Call Ratio – Modified Formula

Where-

• Total Put Open Interest is the total number of outstanding puts; and

• Total Call Open Interest is the total number of outstanding calls.

Example of the Put-Call Ratio

An investor is looking to use the put-call ratio as a preliminary measure of sentiment on a security. The security showed the following puts and calls initiated over the more recent trading day-

The put-call ratio for the security is; = 0.7353

Importance PCR

Put/Call ratio is an important tool used by traders to gauge the overall sentiment of the market. Put/call ratio help traders decide the price movement of an underlying security and guides them to place directional bets on the stocks. Being a contrarian indicator, it helps traders not to get trapped with Herd Mentality. As the ratio is calculated both in terms of open interest and volume, the entire trading behaviour of market participants can be analysed using the Put/call ratio.

How to analyse PCR (Put Call Ratio)?

Let’s see how PCR analysis can be interpreted taking option sellers into consideration who are the major players in the market as compared to the retail public who are usually on the buying side of the trade.