put-call ratio investment & finance definition
The
volume of puts that traded on a given day divided by the volume of calls. The
ratio can be calculated for the overall volume of options trade or for a
certain futures, stock, or stock index. The ratio is used as an indicator of
investor sentiment. When the ratio is too high, or near the top of the chart,
it can signal a time to buy, and vice versa. Technical traders believe that the
ratio is a good contrarian indicator. The reasoning assumes that most options
investors will be wrong.
See put-call ratio in Wall Street Words
A ratio that compares the trading volume in put options with the trading volume in call options. Technicians use the put-call ratio to forecast market turns. A high ratio with heavy trading in puts indicates strong bearish sentiment and the possibility of a market bottom. A relatively low put-call ratio with heavy trading volume in calls indicates very bullish sentiment and a probable market top. As with many other technical indicators, use of the put-call ratio assumes that most investors are wrong.
Case Study Like most technical indicators, the put-call ratio can prove very misleading when it is influenced by unusual factors. In February 1996, the ratio nearly reached five, meaning that put options were nearly five times as active as call options. This high ratio would usually be interpreted as reflecting very bearish investment sentiment, and it caused many investors to view the stock market with great caution. Contrarians, who believe the majority of investors are usually wrong, would consider the unusually high ratio to be very bullish. In fact, the ratio was artificially high and was providing false signals to both groups of investors. The heavy trading in put options was largely the result of the owners of puts selling existing holdings of these contracts and simultaneously purchasing different put contracts. For example, a holder of March put options would sell those contracts and replace them with April put options. Rolling the options forward caused a great deal of activity in put options even though a large portion of this activity represented the trade of existing holdings of puts for different puts.
