Put Call Ratio (PCR) Analysis: How to Identify Bullish or Bearish Trends in the Market

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Marketopedia / Learn about Option Strategies / Put Call Ratio (PCR) Analysis: How to Identify Bullish or Bearish Trends in the Market

The Put Call Ratio

The Put Call Ratio (PCR) is a straightforward calculation that helps us identify when the market is particularly bullish or bearish. Traders traditionally interpret this contrarian indicator to mean that if the PCR reading is very bearish, it implies the market will turn and become more positive, thus traders go long. The opposite applies as well: extreme bullishness signals for traders to act bearishly.

To determine PCR, simply divide the open interest of Puts by that of Calls. The figure typically ranges near one.

As on 10th May, the total OI of both Calls and Puts has been calculated. Dividing the Put OI by Call OI gives us the PCR ratio –

37016925 / 42874200 = 0.863385

The interpretation is as follows –

  • If the PCR value is above 1, for instance 1.3, this may suggest an excessive bearishness in the markets and could be an indication of its being oversold. This could lead to possible reversals resulting in price increases.
  • PCR values of 0.5 or less suggest an abundance of calls being bought, signalling the markets have become highly bullish and potentially overbought. In such cases, one should watch for a reversal and anticipate a downturn in the markets.
  • Regular trading activity can be observed in values between 0.5 and 1, therefore these readings can be disregarded.

Clearly, plotting the daily PCR values for a period of 1-2 years can help identify extreme bearishness. For Nifty, it could be 1.3 while Infy may indicate a value as low as 1.2. Back testing also plays a role in providing clarity on this issue.

One may question why the PCR is seen as a contrary indicator. It is quite difficult to explain the reason behind this, however, the general belief is this; if traders have already taken their bullish/bearish stance, then most of the market participants have established their positions (causing a high/low PCR). Therefore, very few other traders are available to further push the stock/index in that direction. As a result, it will ultimately be levelled off and this leads to driving it in the opposite direction.

That’s PCR. There are variations to this technique – some choose to use total traded value instead of OI, and others opt for volumes. However, I don’t think it necessary to over-analyse PCR.