The put/call ratio is a sentiment indicator that compares the number of put options traded with the number of call options. Buyers of calls generally expect prices to rise, and buyers of puts expect them to fall or want protection. The ratio therefore shows how fearful or confident options traders are. Martin Zweig did much to popularize it as a market timing tool, and it is usually read as a contrarian indicator: extreme fear tends to appear near lows and extreme confidence near highs.
How it is calculated
Put/Call Ratio = put volume / call volume (contracts traded in a day)
A reading of 1.0 means as many puts as calls changed hands. Several versions are published, and they behave differently:
- Equity put/call ratio. Options on individual stocks only. Speculative traders dominate this market, so it is the version most often used to read crowd sentiment.
- Index put/call ratio. Options on indexes such as the S&P 500. Institutions buy index puts to hedge portfolios, so this ratio runs much higher and reflects hedging as much as opinion.
- Total put/call ratio. All options combined, a blend of the two.
Some traders weight the ratio by the dollar value of the options or use open interest instead of volume. Because the daily figure jumps around, it is usually smoothed with a 5-day or 10-day moving average.
How to read it
- High readings, fear. When the ratio rises well above its normal range, traders are buying protection or betting on a decline. Read as a contrarian signal, that pessimism often appears near short-term lows, because the selling it reflects has largely happened.
- Low readings, complacency. When call buying dominates and the ratio falls well below its normal range, optimism is high. After a long rally that can warn of a pullback.
- Spikes versus trends. A one-day spike in fear is a more useful signal than a ratio that drifts higher over months. A slow rise can simply mean more hedging as a market climbs.
- Confirmation. Extreme sentiment works best as a warning that the market is stretched. Traders wait for price, breadth or momentum to turn before acting on it.
Settings and common mistakes
- Fixed levels across years. The normal range shifts as the options market changes. The rise of very short-dated options in recent years has changed the mix of volume, so levels that marked extremes a decade ago may not mark them now. Compare a reading with its own recent history, for example its moving average or its range over the past year.
- Mixing versions. Equity, index and total ratios have different ranges. A level that is extreme for one is ordinary for another.
- Treating hedging as a forecast. Many puts are insurance on stocks that investors own and intend to keep. A high index ratio does not mean investors expect a crash.
- Acting on the first extreme. Sentiment can stay extreme for weeks in a strong trend. The ratio says the crowd is leaning one way, not when it will stop.
Related tools on MarketInOut
Our screener does not carry options data, so the put/call ratio is not in our formula language. The VIX, which is calculated from S&P 500 option prices, is another options-based gauge of fear and works as a market filter with price@vix. Stocks in a long-term uptrend that have pulled back while the VIX is above 20 (otherwise the screen returns nothing):
exch(nyse,nasdaq) and type(stock) and price > 1 and advol(21) > 1
and price@vix > 20 and price > sma(200) and rsi(14) < 40
Related: McClellan Oscillator, Advance/Decline Line, Dow Theory.
