Put Call Ratio

Wouldn’t it be nice to know how investors are betting on the market or a stock, up or down? Yes, the “Shares Short” and “Short Ratio” statistics can indicate investor’s bias, but the Put/Call Ratio a better market indicator for showing the immediate investor sentiment. There are two types of Put/Call Ratios: standard Put/Call Ratios and Dollar-Weighted Put/Call Ratios. We will start with standard Put/Call Ratios, aka CBOE Put/Call Ratio, since most options data services only show this ratio. However, the general use of both types of Put/Call Ratios are pretty similar. Beginners do not need to get too caught up with the details.

You don't have to know much about options or trade options to use the Put/Call Ratio in your market analysis and trading decisions. Just know that call options are bets for a stock or the market to go up. Conversely, put options are bets for a stock or the market to go down. The Put/Call Ratio compares the put options to call options. In other words, the Put/Call Ratio compares down bets (put options) to up bets (call options).

• Put/Call Ratio > 1.0. Investors are buying more puts (down bets) than calls (up bets), so the overall bet is down.
• Put/Call Ratio < 1.0. Investors are buying less puts (down bets) than calls (up bets), so the overall bet is up.

It is important to know that call options and put options expire on a monthly basis. You can buy options that expire in a month, 2 months, 3 months, etc. But at some point, you must either cash them in or let them expire worthless.

How does this apply to the Put/Call Ratio? The up bets and down bets are bets on the immediate future. If these bets don’t work out within a month or two, most of these bets will expire worthless. On the other hand, investors can be short a stock (down bet) for months or even years, just like investors can buy and own stock (up bet) for years.

Everyone knows the stock market moves up and down.  What throws most people off is the market appears unpredictable to the untrained eye, making it hard to “buy low” and “sell high” when you don’t know where the low is or where the high is.  

No one knows for sure where a high or low is, but statistics such as the Put/Call Ratio can tell you when a high or low is very likely.  The trick to effectively using the Put/Call Ratio is only when the Put/Call Ratio is at extremely high readings or extremely low readings.  When that happens, it is best to go against, i.e. contrary, the overall bet.  In other words, be a “contrarian.”

For example, when the Put/Call Ratio is extremely low (a ton of up bets and few down bets), it shows everyone believes things couldn’t be better and has spent all their money betting on how perfect things are.  But the world is never perfect.  When this happens, those who have already made money will sell to take profits.  Since all the buyers have already spent their money betting on how perfect things are, there are not enough people to buy from the sellers, causing the market to go down.  This may be temporary.  It is hard to tell from the Put/Call Ratio alone, but a high has occurred for the time being.

As Options legend Larry McMillan explains,

“The standard put-call ratio is simply the volume of all put options that traded on a given day divided by the volume of call options that traded on that day.”

On the other hand, Larry McMillan explains the Dollar-Weighted Put/Call Ratio as

“constructed by using not only the volume of the various options, but their prices as well. The two (option closing price and total option daily volume) are multiplied together, and the total of that product for all put options is divided by the total of that product for all call options. What this weighted ratio attempts to show, which the standard ratio does not, is how much money is being spent on puts vs. how much money is being spent on calls.”

Both types of Put/Call Ratios can be calculated for an individual stock, index, or futures underlying contract, or can be aggregated.

Because Dollar-Weighted Put/Call Ratios, to be calculated in real-time, requires a ton of computational power to calculate both the price and volume for all option strikes for each stock, most stock data and options data providers do not provide Dollar-Weight Put/Call Ratios. It is simply too expensive to calculate such massive amount of data. However, one of the top professional sources for real-time Dollar-Weighted Put/Call Ratio data for stocks is Hamzei Analytics.