| The
Put-Call Ratio
Put-call
ratios are useful, sentiment-based, indicators. The put-call
ratio is simply the volume of all puts that traded on a
given day divided by the volume of calls that traded on that
day. The ratio can be calculated for an individual stock,
index, or futures underlying contract, or can be aggregated.
For example, we often refer to the equity-only put-call
ratio, which is the sum of all equity put options divided by
all equity call options on any given day. Once the ratios
are calculated, a moving average is generally used to smooth
them out. We prefer the 21-day moving average for that
purpose, although it is certainly acceptable to use moving
averages of other lengths. |
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"Congratulations
! You
did predict the present crash when you announced that the VIX was
too low. Thank you for the information about the Put/Call
ratio."
Sylvia Kantor
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for larger view
The
chart above is a sample one B of IBM. Buy and sell points are
marked on the chart. Note that buy signals occur when the ratio is
"too high" (i.e., near the top of the chart) and sell
signals occur when the ratio is "too low" (near the
bottom of the chart). The chart below is that of IBM common stock,
with the put-call ratio buy and sell signals marked on it. You can
see that, in general, the signals are good ones. In reality, we
couple technical analysis B using support and resistance levels B with
the signals generated by the put-call ratios. The combining of the
two methods normally produces better-timed entry and exit points
in our trades.
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A
dollar-weighted put-call ratio is constructed by using not
only the volume of the various options, but their price
as well. The two are multiplied together, and the total of that
product for all put options is divided by the total of that
product for all call options. That computation is the daily
weighted put- call ratio. As with the "standard"
put-call ratio, this weighted ratio can be computed for individual
stocks, futures, or indices, or for aggregated groups of options.
Formally stated, the weighted put-call ratio can be written
mathematically as shown in the box below. What this weighted
ratio attempts to show, which the "standard" ratio does
not, is how much money put buyers are spending.
The
thinking is that it is more important to know how much total money
is being spent on puts versus calls, than merely to know the
volume. This point has some validity. For example, a person who is
merely hedging his position perhaps is not really all that
bearish, but just wants to buy some puts as insurance. He might
buy fairly deep out-of-the-money puts. Thus, his dollars would be
spent on rather low-priced puts. On the other hand, a truly
bearish speculator would most likely buy a put with a higher delta
B something that is at-the-money, or perhaps slightly
in-the-money. Thus, this "true" bearishness would
perhaps result in a higher expenditure in terms of dollars.
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The
main difference between the "normal" and weighted ratios
is that the weighted put-call ratio generates more extreme
readings - especially at major turning points.
That is, during bullish periods the weighted reading can dip down
to 0.20 or below on a given day, even pushing the 21-day moving
average down to those minimal levels at times. The
"standard" put-call ratio rarely gets that low,
especially where equity options are concerned. Furthermore, during
extreme bearishness, the weighted ratio will easily rise above
2.00 on individual days, and the 21-day average can rise to nearly
2.00 as well. Again, those kinds of numbers are generally unheard
of for the "standard" ratio.
As
an example, let's look at the big picture, via the equity-only
charts. The two charts below show the "normal" ratio (on
the left) and the "weighted" ratio (on the right). The
buy and sell signals are marked on the charts. For these charts,
the major buy and sell signals occur at relatively the same points
in time.
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