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The total put/call ratio is the volume of puts divided by the volume of calls traded on individual equities and indices on the CBOE (Chicago Board Options Exchange) on a given day. 


A put is an option contract commonly used to profit on a declining stock - traders usually buy them to hedge an existing position or speculate on a stock or index they believe will decline soon.  Conversely, a call is an option which gives the buyer the right to buy a stock at a certain price by a certain time, and is most commonly bought by traders who wish to profit on a stock or index they believe will quickly rise in price. 


Since most of the options contracts are bought to open, and not sold to open, we can be fairly confident that most of the volume represents purchases (SPX options, or those traded based off the S&P 500 index, is a notable exception).  Generally, heavy volume in put contracts shows large-scale fear by options traders, while heavy call volume is usually a reflection of increased investor optimism regarding rising prices. 


When there is a lopsided shift in volume, for example when there is heavy put buying and low call buying, the put/call ratio will be high.  When an extreme is reached, this becomes a bullish contrarian indicator and we should expect higher market prices soon.  Conversely, when options traders are optimistic and there is low put volume in relation to call volume, then the put/call ratio will be low and we may be near a market high.


The total put/call ratio is most easily computed using data from the Chicago Board Options Exchange (CBOE).  The ratio is computed simply:


Total put/call ratio = total put volume / total call volume


The CBOE makes it easy for you to monitor the total put/call ratio each day - they do the calculations for you.  The chart below is a snapshot of the CBOE website for February 7th, 2003:



We can see here that the total put/call ratio for February 7th was .94.  Phrased another way, there were 94 puts traded that day for every 100 calls - quite a high reading for that time.


Because the day-to-day movements in this ratio are so erratic, we follow them on a 10-day and 21-day moving average basis, which corresponds to the most recent two-week and one-month period (trading days).



Put/call ratios tend to show secular trends depending on the market environment (i.e. low put/call ratios are common during a bull market and high put/call ratios are common during a bear market), so there is no set level that can be considered extreme (not even the "1.0" level that is commonly believed to show excessive pessimism). 


On the chart, the green and red bands are 1 and 2 standard deviations from the recent mean.  When the put/call ratio exceeds one of those levels, then a notable event has occurred.  The most effective signals occur when the ratio is high and the market is in an overall uptrend (buy signal), or when the ratio is low and the market is in a downtrend (sell signal).  For the 10-day and 21-day moving averages, the green and red bands are 1.5 standard deviations from the one-year mean.


The chart below shows an occurrence of the total put/call ratio violating its lower standard deviation band in August 2002.  The market had been in an uptrend followed the panic low in July.  After several explosive days higher, the options crowd began to get quite optimistic, and call volume began to skyrocket.  Call volume got so high compared to put volume, in fact, that the ratio dropped well below its lower trading band.  It happened not only once, but again a few days later, and the market peaked immediately after.



Although this is a real example and points out the value of following this information, we do not mean to intimate that the market ALWAYS peaks when the put/call ratio violates its lower band, or troughs immediately after the ratio exceeds its upper band.  It is a guideline and not a trading system unto itself.


  Since 1995 Since 2000
Mean 0.68 0.70
St. Dev.* 0.15 0.17
Maximum 1.36 1.36
Minimum 0.29 0.37


*Standard Deviation.  See below...


68% of readings (1 standard deviation) should be between .53 and .87

95% of readings (2 standard deviations) should be between .36 and 1.04

99% of readings (3 standard deviations) should be between .19 and 1.21


In other words, we should expect a reading under .19 or over 1.21 only between 2-3 times per year.  Since such a reading would be highly unusual, it suggests that we are seeing an unsustainable trend.  These figures assume a normal distribution curve, which is not necessarily true in this case.  Since 1995, this data has shown a relatively significant skew (few very small readings but more significantly large readings).  However, recently this skew has begun to lessen as the mean has increased, making the distribution more normal.



Chicago Board Options Exchange (www.cboe.com)


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