Put-Call Ratio Meaning and How To Use It To Gauge Market Sentiment

What Is a Put-Call Ratio?

The put-call ratio is an indicator of whether investors as a whole are placing more bets on prices falling or rising. It’s a crucial yet underplayed measure of market sentiment, especially compared with better-known metrics like the Cboe’s Volatility Index (VIX).

Key Takeaways

• The put-call ratio provides a broad view of the volume of put options bought in the market to that of call options.
• It’s often used to measure market sentiment.
• Traders buying more puts than calls indicates a bearish market.
• If they are buying more calls than puts, they are expecting a bull market.

Understanding the Put-Call Ratio

A “put” is a right to sell, and a “call” is the right to buy an asset at a preset price. If traders are buying more puts than calls, this signals a rise in bearish sentiment. If they are buying more calls than puts, it suggests that they are bullish. While you’ll read more about the put-call ratio for the S&P 500 index or the overall market, you can also look at individual put-call ratios for specific securities.

This widely-watched indicator compares how many put options (bets that prices will fall) are being bought versus call options (bets that prices will rise). When more investors are buying puts than calls, it suggests growing pessimism about the market’s direction.

Note that this ratio is different from put-call parity, which is a principle defining the relationship between the prices of put and call options. Instead, the put-call ratio focuses on trading volume and provides insights into whether traders are positioning themselves bullishly or bearishly in the options market.

Note

You can think of puts as insurance policies against falling prices, while calls are like tickets to profit from rising prices.

A put-call ratio of 1.0 means that the number of buyers of calls is the same as the number of buyers of puts. However, this ratio is not the typical “neutral” reading of market sentiment because there are usually more investors buying calls than buying puts. So, an average put-call ratio of 0.7 for equities is considered a reasonable basis for evaluating sentiment.

Here are two general principles on how to read the ratio:

• A rising put-call ratio, or a ratio greater than 0.7, means that equity traders are buying more puts than calls. It suggests that bearish sentiment is building in the market. Investors are either speculating that the market will move lower or are hedging their portfolios in case of a sell-off.
• A falling put-call ratio below 0.7 and approaching 0.5 is considered a bullish indicator. This means more calls are being bought than puts.

The data used to calculate put-call ratios are available through various sources, but most traders use the information found on the Cboe Options Exchange website.

The put-call ratio is like the market’s fear gauge—when it spikes, it tells us investors are getting nervous and seeking protection.

Calculating the Put-Call Ratio

The put-call ratio is calculated by dividing the number of traded put options by the number of traded call options. This ratio can be calculated for individual stocks, indexes, or even the entire market:

Put-Call Ratio = Number of Puts Traded / Number of Calls Traded

For example, if traders buy 1,000 put options and 500 call options in a day, the put-call ratio would be 2.0 (1,000/500), signaling notably bearish sentiment. However, the ratio’s interpretation requires context—what’s considered “high” or “low” varies across different market conditions.

While trading volume (# of contracts traded) is used most often, the ratio can also be used in call vs. put open interest (or any changes).

Experienced traders tend to review the ratio’s trend rather than just the number itself. A steadily rising or falling ratio often precedes significant market turns.

How to Obtain the Data for the Ratio

Data for the put-call ratio is publicly available from the Cboe on its daily market statistics page. The Cboe and other options exchanges also report daily trading volumes for put and call options across various underlying assets. The Options Clearing Corporation provides this data as well.

Some financial data providers and brokerage platforms also offer put-call ratio data as part of their market analysis tools. Traders can access this information in real-time or on a delayed basis, depending on their subscription level and the specific data service.

Interpreting the Put/Call Ratio

The put-call ratio is often a contrarian indicator, meaning extreme values may signal potential market reversals. However, the best interpretation depends on your trading strategy and market outlook.

Typically, investors compare current ratio levels to the average over a given period to gauge recent sentiment. If the put-call ratio has been fluctuating in a tight range and suddenly bumps higher, traders might see this as a sudden increase in bearish sentiment and respond.

One common mistake is viewing extreme put-call ratios in isolation. Always consider the broader market context and use other metrics before leaping to any conclusions.

Momentum Traders

Momentum traders may use the put-call ratio to identify and ride existing trends, often with other indicators or chart patterns.

For example, they might interpret a rising put-call ratio as confirmation of a bearish trend, potentially leading to further downside. Alternatively, a falling put-call ratio could be seen as confirmation of a bullish trend, potentially leading to further upside.

Momentum traders will use the put-call ratio with other technical indicators to confirm trend strength and identify potential entry or exit points.

0.70

A ratio of 0.70 is the average that’s considered a good basis for evaluating sentiment. This level suggests a healthy balance of hedging with a bullish tilt.

Contrarian Traders

Contrarian traders often look for extreme values in the put-call ratio to identify potential market turning points where traders are becoming overly bullish or bearish.

They might interpret a very high put-call ratio (e.g., above 1.5) as a sign of excessive pessimism, potentially indicating an oversold market ready for a bullish reversal. Alternatively, they might see a very low put-call ratio (e.g., below 0.20) as a sign of excessive optimism, potentially indicating an overbought market ready for a bearish reversal.

Contrarian traders tend to believe that when sentiment reaches extreme levels, it signals that most traders have already positioned themselves in one direction, leaving limited room for further movement in that direction.

Nevertheless, while the put-call ratio can provide valuable insights, it should not be used in isolation. Traders and investors typically combine this indicator with other technical and fundamental analysis tools to make more informed decisions.

Important

No single ratio or indicator can definitively indicate that the market is at its top or bottom. Even the levels of the put-call ratio that are considered extreme are not set in stone and vary over the years.

Additional Considerations

The put-call ratio can help investors gauge market sentiment before the market turns. However, it’s important to also consider additional factors that are relevant to the options market and which may influence the interpretation of the ratio:

• Time frame: The put-call ratio can be calculated over different periods, such as daily, weekly, or monthly. Longer time frames may provide a broader perspective on market sentiment. Traders may use several time frames to gain a more comprehensive view. For example, comparing the daily ratio to its weekly or monthly average can help identify significant deviations from the norm.
• Volatility: During periods of high market volatility, the put-call ratio may fluctuate more rapidly, potentially leading to false signals. The ratio’s effectiveness as a contrarian indicator may be reduced during extreme volatility, as the normal ways investors behave can break down.
• Market context: Interpreting the put-call ratio should always be done while considering market conditions, news events, and other relevant factors affecting investor sentiment. For example, trading volume often spikes as options approach expiration, potentially causing short-term distortions in the ratio.

What Is a Good Put Call Ratio?

Generally, .70 is considered the average ratio on which to base judgements. There are certain rules of thumb (e.g., above 1.50 or below 0.20) that depend on the context and other factors at play. Traders will want to look at the historical path of the put/call ratio for the underlying security to see what values are at extreme levels. Take particular note of outlier ratios to determine if the indicator is at an extreme level, suggesting a trading opportunity.

What Does A PCR of 1.3 Mean?

A put-call ratio of 1.3 means the market is more bearish in anticipation of a downturn.

What Is the Relationship Between the Put-Call Ratio and the VIX?

The put-call ratio and VIX often move in tandem, with simultaneous increases indicating rising market fear. However, divergences can be revealing. A rising put-call ratio with a stable VIX might signal sector-specific concerns rather than broad market fear.

Sometimes, changes in the put-call ratio precede VIX moves, potentially providing early warning of volatility spikes. Analyzing these indicators together offers a more nuanced view of market sentiment and potential future volatility.

The Bottom Line

The put-call ratio is very helpful for gauging whether the market outlook is bullish or bearish for a particular security or an index. Low ratio numbers, like 0.2-0.3, suggest that the market sentiment is highly bullish, while reading over 1.2 indicates that the market is becoming too bearish and may be due for a bounce.

The put—call ratio is an excellent barometer of market sentiment and likely positioning. Contrarian traders may take such readings as the basis for a trade, while a longer-term investor may use extreme levels to pare back or add to existing positions. Studying the historical path of the put-call ratio of a particular security can help isolate areas of extreme sentiment and alert traders to potential reversals amid an ongoing trend.