Future and option trading market is the key market wherein risks are often hedged, and the f&o stock traders often take a leveraged bet on stocks as well as indices. Investing in such markets can prove to be exciting. However, in case you are a new investor in the market, you must consider learning certain new strategies.
For this, you do not need to go any further but ask any F&O (futures and options) trader. They will enlighten you about the put/call ratios (PCR). PCR or put call ratio is one of the ways that help analyse the market sentiment. This indicator provides an understanding on how the markets, security plans, funds are trending. It is a commonly used metric that suggests the ratio of puts to calls. This assists you to understand whether a specific increase or drop in market is massive and if there is any requirement for contrarian call. When put call ratio drops to a lower level, it is considered as bullish. Expert traders employ the PCR as a barometer for complete market outlook and as a production indicator. Like S&P 500, PCRs too are comprehensive indices used as a common market measure.
What is the put option?
A put option is the right to trade or sell securities or assets at a specific predetermined amount. You make a put as you expect the deposit price would fall in value. If the value falls below the target value before the termination date, you would earn a profit.
What is the call option?
Call option, on the other hand, is the reverse of put option. It is the power to purchase assets or securities at a predetermined value. Maintaining a call option means you anticipate the security price would increase in value.
PCR interpretation – How should you analyse the PCR?
- In case the put call ratio is over 1, it indicates that there are higher puts being purchased in the market than calls. It shows that there is bearish/falling market sentiment. At this point, you may sell or trade futures or call options to gain the benefit from the expected short covering. Generally, a massively high number over 1 shows an oversold market. However, there is an expected reversal of the situation and the market can go up.
- In case the put call ratio is less than 1, it indicates that there are higher calls being purchased in the market than puts. It shows that there is a bullish/rising market sentiment. At this point, you may buy underlying security. Generally, a massively low number below 1 shows the market is over purchased and an expected reversal is possible i.e., markets can move downwards.
What is a neutral put call ratio?
The put call ratio is not fixed and varies with changes in the market sentiments. However, a market of ratio value equaling 0.7 is observed as a compass. The put call ratio over 0.7 or more than 1, indicates falling or bearish market trend. Likewise, when the value of put call ratio falls below 0.7 and decreases below 0.5, it means traders are purchasing higher calls as compared to put. This shows a growing bullish market trend.
The put call ratio shows how the market recognises the current events of earning. When reviewing the put call ratio, it is crucial to view the value of denominator (call) and numerator (put), both. Some exchanges of calls can bring up the put call ratio without any considerable change in the put option’s value, which can endow a false impression about the market sentiment.