Put/Call Ratio (P/C Ratio) – was created by Martin Zweig who gave it the following definition – it is a psychological market indicator that depicts the correlation among the volumes of trades on Put and Call options on a stock exchange options.
As the market practice demonstrates, very often options are traded by inexperienced, beginning and impatient investors who are simply attracted by an opportunity of receiving really high profits upon the application of minimum funds. Another very interesting fact that should be mentioned is the following – the behavior of the above-mentioned investors gives amazing signals about the closeness of marketability as well as prospects of the market.
Call options give all traders/investors a right to purchase hundred shares at a strike price (the price that is fixed and determined in advance). Investors, who buy Call options, hope for and lot upon the increase of the prices in the forthcoming months.
The situation is a little bit different with Put options. Here, this type of option (Put) enables investors to sell hundred shares at a fixed price that was set in advance. Investors, who buy Put options usually lot upon the decrease of the price.
In as much as buyers of Call options count for the market increase and buyers of Put options for its decrease, the correlation between Put and Call options depicts and shows bull/bear expectations. The higher the Put/Call ratio is, the more pessimistic their attitude is. And on the contrary, low figures mean a large volume of trades on Call options and consequently domination of bull expectations.
Put/Call ratio interpretation is based on a principle of an “opposing opinion” or how it is also called an “adverse opinion”. When an indicator shows outermost figures and values, the market usually changes its direction to the opposite. Yet there are special marks that are considered to be the main and most important as they help to interpret the Put/Call ratio. Of course, it is clear that the market doesn’t have to correct the direction of its movement just because investors expect extreme optimism or pessimism. As any other instrument that belongs to a technical analysis, Put/Call ratio should be used together with other market indicators. In such a way, the outcome will be always profitable and investors’ expectations satisfied.