The Put Call Ratio
Posted by sellacalloption
Put Call Ratio
The put call ratio can be used to measure market sentiment. It is frequently used as a contrarian indicator. The way it’s calculated is very simple it’s just the number of puts traded divided by the number of calls traded. You’ll see it quoted a couple of different ways, one is the open interest or OI ratio and the other is volume or VOL. The OI ratio uses the open interest on the option contract and the VOL measure uses the volume over a given time frame.
The dollar weighted put-call ratio is the sum of the put volume times the put price divided by the sum of the call volume times the call price.
Contrarians use the put call ratio under the assumption that the public is usually wrong. So when the public is buying a lot of calls, they’ll short the stock and when the public is buying a lot of puts, they’ll buy the stock.
As with any strategy it won’t work 100% of the time and there have been many times when there has been heavy call buying on a stock and the stock ends up getting taken over. A takeover candidate is not a suitable short sell candidate.
Below is a chart of the AGG ETF as of 11-9-2012, the IShares Core Total US Bond Index. The red line below shows the put call OI ratio at 226.00.