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 many 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 the nifty call put ratio, the investor can predict the market’s movement. If the ratio increases, it generally means that the investors are putting their money into put options rather than call options. The increase in the traded put options signals 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.
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The above-mentioned put-call ratio is a commonly used tool by the traders as a contrarian indicator of unusual price levels. These extreme levels can make the investors make wrong decisions; thus, the importance of the put-call ratio is much more in such circumstances. By following the put-call ratio speculations, many traders 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 positions start to look for the cover to save themselves from the massive change.
All this should not be understood so that the put-call ratio will give out some magic number to make a 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 chains, visit BloombergQuint.