Put / Call Ratio

The Put/Call Ratio is a market sentiment indicator that shows the relationship between the number of puts to calls being traded on the Chicago options exchange. The process behind this indicator is that options tend to be traded by somewhat impatient short-term investors who are looking for huge profits with a small outlay of cash. The interesting thing about this is that the actions of these short-term investors can provide good signals for market tops and bottoms.

To the basics – a call gives a trader the right to purchase shares of a stock at a set price. Traders who purchase calls expect the price to rise in the next few months. A put gives a trader the right to sell shares of a stock at a set price. Traders buying puts expect the price to go down in the next few months.

Because traders who purchase calls expect the market to rise, and traders who purchase puts expect the market to fall, the relationship between the number of puts and calls shows the bullish and bearish expectations of these traders.

The Put/Call Ratio is considered a contrarian indicator. When it reaches extreme levels, the market usually corrects in the opposite direction.

The Put/Call Ratio, as with all the other indicators we have discussed the last few weeks, should only be used in conjunction with other indicators. For those with an interest in this indicator, start watching it and get familiar with it before basing any trade decisions on it. For all of our readers, I offer a toast to another great year of trading and financial success for everyone.

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