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What is the put-call ratio and why should I pay attention to it?

What is the put-call ratio?

While investing in the stock market, Genius Zone  there are a lot of factors that need consideration from the investor’s side. One small mistake can cause a big blunder while on the other hand carefully did speculations, observations and calculations can turn the whole table upside down towards large profits. In the past few decades, there are a large number of different tools designed to understand the path on which the market is going. The put call ratio is one such that was specifically designed to help the investors working as an individual to understand the overall mood of the market.

How is it calculated?

The put-call ratio may look simple enough to calculate but it holds a large amount of information that can be helpful for the investor. It is calculated by dividing the number of traded put options by the number of traded call options. By keeping an eye on the increase or the decrease in the ratio for example on nifty call put ratio, the investor can predict the movement of the market. If the ratio is increasing, it generally means that the investors are putting their money into put options rather than call options. The increase in the traded put options gives out the signal that the investors are speculating the fall of the market or planning to hedge their portfolios in case of a sell-off.

Why should you pay attention to the put-call ratio?

The increase in the put-call ratio can be determined as a clear indication that the investors have started to move toward instruments that gain with the fall in price rather than when the price rises. As the number of call options can be seen in the denominator of the ratio, the reduction in the number of traded calls will cause an increase in the value of the ratio. The significance of such change is that it is a clear indication that the market has started to dampen the bullish outlook it has.

The above mentioned put-call ratio is a commonly used tool by the traders as a contrarian indicator at the time of unusual price levels. These extreme levels can make the investors take wrong decisions thus the importance of put-call ratio is much more in such circumstances. Many traders by following the put-call ratio speculations will consider a large ratio a sign of a buying opportunity as they believe that the market holds an unjustly large outlook. It is believed that in such cases the market soon adjusts itself as soon as the traders with short position start to look for the cover to save themselves from the massive change.

All this should not be understood in a way that the put-call ratio will give out some magic number to make the clear prediction about the market. It is more about the general prediction made by the traders while looking at the spike or fall in the market which is outside the normal trading range. The ratio indicator can easily be created in a spreadsheet and the data which is required for such calculations are easily available via different sources.

For more on futures contracts and option chain, visit BloombergQuint.

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