Another market sentiment indicator: Put/call ratio


Another indicator for market sentiment besides AAII is put/call ratio (PCR). PCR shows whether most investors are trading long or short, while AAII is a survey that suggests how investors “feel”.

What’s put/call option?

Option is a contract where the buyer can buy or sell a stock at a fixed price, or strike price, within a specified time frame. Put option is the right to sell the underlying asset at strike price; call option is the right to buy the underlying asset at strike price. Investors can decide whether they want to long or short their options.

You can use a combination of option contracts that have different expiry dates to reduce risks. When you expect an increase in the price of a financial asset, you can long call options. When you expect a decline in the price of an underlying stock, you can long puts.

When call volume is higher than put volume, it suggests optimism in the market. On the contrary, when people purchase more puts than calls, it suggests a general bearish sentiment in the market.

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What does open interest indicate?

Open interest is the total number of unexercised contracts. The highest strike price among all outstanding calls is considered the highest price the stock could reach. The lowest strike price among all open puts is considered the lowest price the stock could go.

What does put/call ratio represent?

PCR indicates the overall expectations of market trend. It increases as investors lean on the bearish side and declines as investors become exuberant on stocks.

If 10-day average exceeds 1.1, the market is reaching a temporary bottom. Below 0.8 suggests that the market is moving towards a peak price. The highest and lowest strike price among all open contracts also indicate the price range the market is moving within.