Welcome to yet another article regarding advanced option trading strategies for beginners. IN our previous article, we had discussed the change in open interest. We had learned how a change in open interest can make a difference in the market movement. Now, we are going to discuss the put-call ratio or simply just PCR. It is one of the most important aspects of options trading for beginners.
What is PCR or Put Call Ratio?
Put call ratio which is also called PCR is not only a ratio but is a wonderful golden indicator. If you understand how to read the put-call ratio in this article that I am going to tell you, you can be a great successful options trader. How to use Put call ratio? It is a very simple ratio and widely available ratio in the options market and how to use them to understand what is happening in the market, what the market participants are thinking about the future of the market, and what can be the movement of the market?
As you know, we have already completed our basic option trading strategies. We are understanding the various indicator which will help us to understand the market view in detail. For any of the options trading strategies, we have to know the market, where the market is supposed to be going in 1 month or 3 months, and using this indicator, we can easily find out.
Now, we are going to learn about something called put-call ratio or PCR which is a very powerful indicator. If you can understand that and again in the last article, I told you that there are two kinds of indicators. The first is called the active indicator and another indicator is called a passive indicator. Indicators show the full data from the minds of the option traders, option sellers, and passive indicators tell you something which is not directly applicable to the options market but you can draw some conclusions from the indicators.
But this PCR or put-call ratio is an activity indicator that means it gives you what is going on in the mind of the options trader. Firstly, what is PCR? The put-call ratio is an estimation that is widely used by investors to find out the overall scenario of a market.
A put option is a right to sell an underlying asset at a fixed price. A call option is a right to buy an underlying asset at a fixed price. If traders are buying more put options than a call option, it signals a rise in the bearish signals. If they are buying more call options than put options, it indicates that they see a bull market ahead.
A put is a derivative tool that gives the holder the right, but not the assignment, to sell a particular amount of an underlying asset at a fixed price within a specified time frame. A call functions in the same way, but gives its holder the right to buy rather than sell.
Holders of puts are expecting the price of the underlying to go down. Owners of calls, on the other hand, are looking for the price of the underlying asset to go up.
The put-call ratio gives the information about relative the trading volume of an underlying asset’s put options to its call options. It has long been observed as an indicator of investor mind in the markets, where a large proportion of puts to calls shows bearish signs, and vice versa.
Before knowing about the put-call ratio formula, it is very important to understand the components of this ratio one by one. For instance, the put option gives traders the right to buy the assets at prefixed prices, whereas, the call option gives the right to buy assets at the current market prices. If you are going to learn the put-call ratio, it is very simple. It is a put divided by call. So, the number of put open interest divide by the number of call open interest which is available for any stock or any index on a particular day. So, it is measured day by a day basis on any given day.
Let me then explain to you what it tells you. To understand when people sell put, the option seller who is considered a wise man in the stock market because they are most of them are either institutional investors or big rich people. To sell the options you have to give the margins to the exchange and these margins are not a small amount, it is you can say a huge amount.
It is considered that only the rich person can be in option selling but this is not the case. I already told you that even you have 5,00,000 rupees, you can do option selling. If you want to do something on a professional level that you should have, then as I understand, minimum 10 lacs to 20 lakhs rupees in which 10 lakhs in action and 10 lakhs as a backup. If you have 20 lakh rupees, then something if you have, you can jump into selling the options.
So, when we understand that a simple person with a selling option is sitting with a portfolio of 20 lakh rupees and the big people may be sitting with a portfolio of you can say 1000 crores. Then we can safely assume that what you are there thinking if somebody is putting 1000 crore as a state, definitely they are going to do more and more data analysis than somebody who is coming with these 5000 rupees. It is a natural phenomenon.
So in conclusion, I would like to tell you that PCR is a very good indicator to know about the market direction. But, before investing your money, you have to do your research first.