Put Call Ratios

For those of you who rely on technical analysis, at least on some of the available indicators, daily, the Chicago Board Options Exchange (CBOE) publish few  put call ratios.

The  Put Call ratio measure the number of put options traded vs the number of call options traded in a day. It is viewed as a indicator of how bearish protection is demanded  against a downturn in equities.

So, on days put/call ratio is above 1, traders are buying more puts than calls (a possible signal that traders are more focused on market weakness). People usually buy puts to speculate in a bear market or, to protect the profits achieved, so, when expect a downturn in the market.

On days the ratio is below 1 it means call volume exceed put volume and market is buying call in anticipation a higher stock prices in near term.

The put/call ratio shows what traders think about the direction of stocks,and is classified as a sentiment indicator.

If a lot of traders think the market is going down and buy puts, you might assume that a high put/call ratio would indicate the market is about to drop. However, historical data show that the ratio is actually a contrarian indicator. At the extremes, when the put/call ratio is high, we can see  the peak as a signal that stock prices will go up. So if the put/call ratio drops well below 1.00, this is a sign the market is about to drop. In the short term,  a high ratio is a sign to buy and a low ratio means you should sell.

The ratio could be calculated for a specific stocks, but CBOE publish some related with the total market, the ratio for indexes only, the ratio for equities only, and few more, each of them with  his own specific characteristics, for example, since it includes index options, which are used by professional money managers to hedge portfolios of stocks, the Total put/call ratio can distort the measurement of the temperature of our purely speculative crowd. Arguably, a better gauge is the CBOE’s Equity-only put/call ratio.

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In any case, if we want to include the ratio in our toolbox, it is important follow it to determine the usual  levels for each ratio and to smooth  the ratio with moving averages if we want to have a bit of perspective .

Consider too, that  in the case of the VIx put/call ratio, whe can say that when ratio is above 1, and people buy more puts, the expectation is a lower Vix, so, a higher market, because Vix declines in bull markets, and isn’t clear for me if in this case Vix can be also considered contrarian.

(A existing strategy could be open long positions in S&P for 1 day just when the vix put/call ratio close above 1. See “Trading with the VIX Put/Call Ratio” )

A good way to look at the ratio is to check basically the rollovers of the ratio.

So, if the ratio is rising this is a bearish sign for the stocks, but  a rollover from rising to falling, when the ratio is “too high”,  is a buy signal (there has been “too much” put buying and it has exhausted itself). A rollover from falling to rising one is a sell signal ( “too much” call buying has been taking place).

A variation of the ratio is to consider the weighted put/call ratio that is calculated not only with the volume but multiplying it by the option price. The idea is that isn’t the same buy ATM puts that buy deeper OTM puts just in case,…. But the signals generated, although a bit more extreme are practically the same. More info at Optionstrategist.com

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CBOE publish the numbers intraday every half hour, so you can check in every 30 minutes is the outlook of active traders is changing.