Investors use a variety of financial indicators to assess market sentiment before investing their money. Put call ratio is one such financial technique that benefits investors in several ways.
To fully understand the applicability and importance of this financial assessment, one must first grasp its fundamentals. Here, we've gone over the details, including the put-call ratio calculation and other information.
What is the Put Call Ratio?
Typically, a put-call ratio is a derivative indicator. It is intended to help traders accurately assess the sentiment of the options market. This ratio is calculated by either factoring in open interest for a certain period or using the volume of options trading.
This ratio, often known as PCR, is a contrarian indicator that focuses on option buildup. This type of indication aids in determining the degree to which the market is bullish or bearish.
In other words, it helps traders determine if a recent market surge or decline is excessive.
Based on this knowledge, traders determine whether to take a contrarian position in the current market.
To avoid mispricing in the securities market, such an investment strategy is based on the practice of acquiring or selling investment units in response to current market conditions.
How to Analyze PCR (Put Call Ratio)?
The meaning of this ratio varies according to the type of investment. PCR is estimated using two methods, as follows:
Based on the open interests of a particular day
- The PCR is determined by dividing the current open interest in a Put contract on a given day by the open Call interest on that same day.
- PCR (OI) = put open interest / call open interest.
Based on the volume of options trading
- PCR is determined by dividing the total Put trading volume by the total Call trading volume on a given day.
- PCR (Volume) = put trading volume / call trading volume
- Put volumes are a financial market indicator that measures the total number of Put options launched during a certain period. Furthermore, call volumes are utilised to calculate the total number of started call choices within that period.
Why Is PCR Important?
The put/call ratio is an essential metric that traders use to evaluate market sentiment. Put/call ratios assist traders in determining the price movement of the underlying security and guiding them to put directional bets on equities. As a contrarian signal, it helps traders avoid the trap of Herd Mentality. The Put/call ratio may be used to examine the whole trading activity of market players because it is computed in terms of both open interest and volume.