Put Call Ratio: A Guide for Options Traders

What is the Put Call Ratio?

In the world of options trading, the Put Call Ratio (PCR) serves as a popular sentiment indicator that reflects the balance between put and call option activity.

To recap:

• A put option provides the right (not the obligation) to sell a specific quantity of an underlying asset.
• A call option provides the right (not the obligation) to buy a specific quantity of the underlying.

PCR is calculated by comparing the volume or open interest of puts versus calls. When the ratio exceeds 1, it indicates that put activity is dominant, hinting at bearish market sentiment. Conversely, a PCR below 1 suggests stronger call activity, pointing to a bullish market outlook.

Types of PCR

There are two primary methods to calculate PCR:

1. Volume-Based PCR
   • Formula:
     Volume PCR = Total Traded Volume of Puts / Total Traded Volume of Calls
2. Open Interest-Based PCR
   • Formula:
     OI PCR = Total Open Interest in Puts / Total Open Interest in Calls

It’s crucial to not assess PCR in isolation. The current PCR value should always be compared with historical levels to identify whether sentiment is excessively bearish or overly bullish.

Sample Calculation:

Let’s look at some hypothetical data for clarity:

• Total Put Volume = 2,06,84,932
• Total Call Volume = 2,23,57,500
• Total Put Open Interest = 14,50,797
• Total Call Open Interest = 21,12,999

Calculated Ratios:

• Volume PCR = 2,06,84,932 / 2,23,57,500 = 0.93
• OI PCR = 14,50,797 / 21,12,999 = 0.69

How to Interpret the PCR

There are two major approaches to interpreting the PCR:

1. Standard Reading

• PCR > 1: Bearish sentiment — more puts than calls.
• PCR < 1 (e.g., 0.70): Bullish sentiment — more calls than puts.

2. Contrarian Perspective

This method treats PCR like a technical oscillator (similar to RSI), helping spot extreme zones.

• Overbought: Market has rallied too much; could reverse soon.
• Oversold: Market has declined steeply; may bounce back.

So, in the contrarian view:

• PCR at 1.5 or above → Market is overly bearish → Traders may buy.
• PCR at 0.50 or below → Market is overly bullish → Traders may sell.

An Alternate View on PCR

Traditionally, PCR reflects option buying activity, but there's another school of thought, focused on option writing (selling).

This perspective suggests that:

• Option writers (especially institutions and hedge funds) are typically better informed.
• Writing puts → Bullish bias → Increases PCR
• Writing calls → Bearish bias → Decreases PCR

Large institutions often hold long positions in stocks and hedge these with put options, thereby increasing put volumes and boosting PCR. When they unwind or take profits, they may hedge by buying calls, increasing call activity and reducing the PCR.

This framework suggests:

• Rising PCR = Bullish undertone
• Falling PCR = Bearish undertone

Points to Remember

While the Put Call Ratio isn't a standalone trading signal, it offers critical insight into market sentiment and helps shape directional trading strategies.

Here are a few key takeaways:

• PCR is best used in conjunction with other indicators.
• Watch for extreme PCR readings but always compare with historical context for indexes and stocks.
• A PCR of 1.3 may be extreme for an index but not necessarily for a stock.