DERIVATIVES Put-Call Ratios by Lawrence G. McMillan
This measure of market sentiment uses options trading volume to measure crowd psychology. Here's one use of the ratio.
The ratio of put option volume to call option volume is the major sentiment indicator for listed options. This ratio, called the put-call ratio, is usually computed daily and moving averages are kept. The resulting indicator is a contrary one: when a great many - too many - people are buying calls, for example, then there are a great many -perhaps too many - bulls, and the interpretation as a contrary indicator would be to sell the market. Conversely, when "too many" people are buying puts, contrarians look to buy the market. Put-call ratios are applicable to various futures markets as well as the stock market, but first, let us look at the stock market.
With respect to the stock market, there are two distinctly different ratios, the put-call ratio of index options and the put-call ratio of equity options. On a typical day, there are normally at least as many index puts as index calls traded, especially if the Standard & Poor's 100 Index (OEX) options is being used as a guide. This is because many investors realize the protective worth of buying puts against their stock positions, and thus this hedging activity inflates the number of puts routinely traded in the OEX. A typical daily reading of the put-call ratio for index options would be around 1.00.
Equity options are another matter, however, since call volume is normally about twice as heavy as put volume in any individual stock's options. Hence, 0.50 is a typical reading for the daily put-call ratio for equity options.