The put/call ratio is one of the most popular sentiment indicators in technical analysis. By measuring the relative volume of put options versus call options, it provides insight into whether traders are positioned for a decline or a rally. This information can be valuable for contrarian trading strategies.
What is the Put/Call Ratio?
The put/call ratio divides the number of put options traded by the number of call options traded. Since puts profit from declines and calls profit from advances, this ratio reflects trader sentiment.
Formula: Put/Call Ratio = Put Volume / Call Volume
A ratio of 0.80 means 80 puts were traded for every 100 calls.
Interpreting the Put/Call Ratio
Basic Readings
- Below 0.70: Low put volume, traders are bullish (potentially too bullish)
- 0.70 to 1.00: Normal range
- Above 1.00: High put volume, traders are bearish (potentially too bearish)
Contrarian Interpretation
The put/call ratio is typically used as a contrarian indicator:
- Very low ratio: Excessive bullishness may precede a decline
- Very high ratio: Excessive bearishness may precede a rally
- Extreme readings: Crowd is often wrong at extremes
Contrarian Example
After a sharp selloff, the put/call ratio spikes to 1.30.
This shows traders are aggressively buying puts for protection or speculation.
Such extreme fear often marks short-term bottoms.
Contrarian traders may look to buy when fear is highest.
Types of Put/Call Ratios
Equity Put/Call Ratio
- Options on individual stocks only
- More volatile and extreme
- Better for short-term signals
- Reflects retail trader sentiment
Index Put/Call Ratio
- Options on indexes (SPX, SPY, QQQ)
- Includes institutional hedging activity
- Less reliable as pure sentiment measure
- May be distorted by large hedge positions
Total Put/Call Ratio
- Combines equity and index options
- Most commonly cited
- Good overall sentiment gauge
- Published daily by CBOE
Warning: Not a Timing Tool
High put/call ratios can stay high (and go higher) during extended declines. Low ratios can stay low during strong rallies. Use the put/call ratio to gauge sentiment extremes, but combine it with price action and other indicators for timing.
Put/Call Ratio Trading Strategies
Extreme Reading Strategy
- Wait for ratio to reach extreme levels
- Above 1.20: Look for buying opportunities
- Below 0.50: Look for selling opportunities
- Confirm with price action before entering
Moving Average Strategy
- Calculate 5-day or 10-day moving average of ratio
- Smooths daily noise
- Look for extreme readings in the average
- More reliable than single-day readings
Divergence Strategy
- Market making new lows with declining put/call ratio
- Shows fear not increasing despite lower prices
- Potential bullish divergence
- Market making new highs with rising put/call ratio
- Shows increasing caution despite higher prices
- Potential bearish divergence
Historical Context
Major Market Bottoms
- Put/call ratio often spikes above 1.0 or 1.2
- Shows capitulation and extreme fear
- Examples: March 2020, October 2022
- Signals contrarian buying opportunities
Major Market Tops
- Put/call ratio often drops below 0.60 or 0.50
- Shows complacency and extreme greed
- Fewer traders buying protection
- Signals contrarian caution
Combining with Other Indicators
The put/call ratio works best alongside:
- VIX: Another fear gauge for confirmation
- TRIN: Volume-based sentiment
- Investor surveys: AAII, Investors Intelligence
- Price support/resistance: Better entry timing
- Moving averages: Trend context
Sentiment Composite
Create a sentiment score using multiple indicators:
- Put/call ratio extreme + VIX spike + AAII bearish = strong buy signal
- Put/call ratio low + VIX low + AAII bullish = strong caution signal
- Multiple extremes together increase conviction
- Single indicator extremes less reliable
Limitations of Put/Call Ratio
- Options activity includes hedging, not just directional bets
- Index options distorted by institutional hedging
- Timing signals can be early or late
- Works better at extremes than in normal ranges
- Should not be used as sole decision factor
Track Market Sentiment
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Summary
The put/call ratio measures trader sentiment by comparing put volume to call volume. High ratios indicate fear and bearishness, while low ratios indicate complacency and bullishness. As a contrarian indicator, extreme readings often signal the crowd is wrong. Use the put/call ratio alongside other sentiment measures and price action for the most reliable signals, and remember that extremes can persist longer than expected.
Learn more: Arms Index (TRIN) and Implied Volatility.