The Put Call Ratio or PCR holds a significant place in determining the overall market direction.The short term traders regularly keep check on Put Call Ratio along with Technical Analysis while taking their trading decisions.Put and Call stands for Put Option and Call Option.
What is Put Call Ratio
By definition,Put Call Ratio is simply a ratio of Open Interest seen at a Put Option Strike to that of Open Interest seen at the same Strike of a Call Option for an underlying security (a stock or market index) in a particular month contract for the Options.By calculation,you may get PCR less than or more than 1 depending upon the Open Interest values.
Open Interest (OI) represents the number of open trades available for a security.These positions are not closed yet.A position for a security is closed when it completes one cycle of being bought and later sold into.
To make things simple and more elaborate about Put Call Ratio,let us take an example of stock of TCS (Tata Consultancy Services ) which was trading at price of ₹ 2445 on 18/07/2014 on National Stock Exchange (NSE).
In figure,we have Option Chain (includes all the traded Put and Call Options for a particular month contract) for TCS.At 2400 Strike Price, we have Open Interest for 2400 Put Option as 169,875 while for 2400 Call Option,it is 269,500.To get PCR,we simply divide the first figure with the last.So;
Put Call Ratio (PCR) = 169,875 / 269,500 = 0.63
Interpreting the Put Call Ratio
Now that we have calculated the PCR and we need to find the applicability of it.While we may get any figure for PCR depending upon the values of Open Interest,the value of 0.60 for PCR is important to us.
If at a Strike Price,the PCR is above 1.80,it shows that the stock or any underlying security has a good support around that level and it may sustain above that level.In our above example of TCS,we have PCR above 1.80 at all Strikes below 2400 Strike such as 2350,2300,2250 and so on.
This implies that 2350 can be a good base for the stock and it may trade above that level comfortably.But it is not necessarily like that as the stock prices depend upon other several factors also.Those factors may lead it to below 2350 but it always has the tendency to come back above 2350.
For PCR value below 0.60 for a Strike Option,this implies that the stock or the underlying security has a significant resistance at that level and the stock may not sustain above that level for too long.
Take example for TCS 2450 strike for which the PCR is 33500/255,875=0.13 which is below 0.60.So it indicates tough resistance near 2450 level.It is interesting to note that the TCS stock kept on trading well above 2450 level on 18/07/2014 for most part of the trading session but closed below 2450 at the end of the day.
Put Call Ratio Values of 0.30 and less than that indicates stiff resistance for the security while a value above 1 indicates strong support for the security at that strike price.These levels are least likely to get breached on either side except in certain news based events.
In this way,we can take the rough idea about the support and resistance levels for the market indices or individual stocks by using Put Call Ratios for various Option Strikes.
Options are the least understood trading tool among the market participants but importantly these are Options which drive the markets.Open Interests keep changing at the Option Strikes daily according to the trades done in the markets and the market moves are affected accordingly.