One of the most important things a trader can do is to figure out what kind of market they are trading in. And, whether it’s a bull or bear market. Understanding what kind of market you are attempting to trade in will not only give you an advantage but will help you identify what strategy you need to apply to the market.
For instance, if a trader is looking to short the S&P 500, and the market has a bullish sentiment, it could prove to be a disastrous trade for the trader. So how can a trader gauge market sentiment? By the put/call ratio. So, let’s get right into it and go through why this is such a great indicator to use for your trades.
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What Is the Put/Call Ratio?
The put/call ratio is the ratio of the volume in trading between the put options trading and the call options trading. Traders and investors use the put/call ratio to measure the market and to gain a better understanding of its sentiment.
For example, it pinpoints the ratio of put and call options and tells the trader if traders are buying more call options, as it might indicate a bullish trend. And vice versa, if traders are buying more put calls, then it may indicate a bearish trend. It’s important to note the demand for calls and puts, the indicator only gives you a ratio to work off of, and additional research is encouraged.
How To Get the Put/Call Ratio?
The symbol for the put/call ratio in Tradestation is $PCVA. You must sign up for monthly access to the put/call ratio from TradeStation. The put/call ratio permission fee is called the Options Price Reporting Authority, (OPRA) fee and is about $1 for monthly access to TradeStation. In Thinkorswim, the symbol for the put/call ratio is $PCALL, and you can access this just by having a free account.
Put/Call Ratio Rule
The put/call ratio is a little unreliable during the first five to ten minutes of the trading day. The put and call ratio has a staggered open on options. However, aside from that, a balanced put/call ratio will always equal 1. It means that there is an equal number of buyers of calls and puts. Below we have formed a good breakdown of what each ratio means, so that way you can apply it to how you read the indicator and trade accordingly.
Put/Call Ratio Basics
- The put/call ratio is below .45 means it is severely negative
- The put/call ratio is between .45 and .65 means it is negative, but not extremely negative
- The put/call ratio is between .65 and .75 means it is slightly negative
- The put/call ratio is between .70 and .85 and is considered neutral. The put/call ratio between .70 and .85 means the market action and the prices of the Dow and S&P can go up or down equally as easy
- The put/call ratio is between .85 and .95 is bullish, but moderate
- The put/call ratio is above 1.0 means it is extremely bullish. If the put/call ratio goes above 1.0, I look to go long
Put/Call Ratio Rule of Thumb
If price action is going up, you’d like to see the put/call ratio going up. If the price action is going down, you’d like to see the put and call going down.
The main way I use the put and call ratio is to make sure there is nothing out of whack in the trading market. The ratio is like a tourniquet. If you are bleeding and you apply it correctly, you will survive. If the put/call ratio gets above 1.0 when the market is selling off, it will hold. If the put/call ratio is not, it will just slow down the bleeding.
However, the put and call ratio is a tool, it’s not the end-all be-all indicator that traders and investors should rely on. It’s a good proficient way to figure out the bullish and bearish sentiment that traders tend to seek. However, You still must do a lot of research analytically and technically to be able to make a sound decision. And even then, sometimes that is not enough. But that’s life as a trader.
How to Trade?
If you are adamant about using the put and call ratio as a tool in your trading toolbox, then you need to understand a few things. First, you need to know when a stock price goes up the value of the call options goes up. And vice versa, when stocks go down the value of put options goes up. When there is a high put/call ratio that means the market is bearish and when there is a low put/call ratio the market is bullish.
So unless you have done an immense amount of analytical research and have found something publicly that other traders have looked over. You may want to go with the grain when trading with the put/call ratio indicator.
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Originally Published: Mar 3, 2018, at 15:44