Put-Call Ratio (PCR): Definition, Formula and Its Calculation

What is the Put-Call Ratio (PCR)?

The Put-Call Ratio (PCR) is a popular options trading indicator that measures the relative trading activity of put options versus call options. It is calculated by dividing the total number of traded put contracts by the total number of traded call contracts for a given period.

• Put options give traders the right to sell an asset at a certain price and are often used as protection against falling markets.

• Call options give traders the right to buy an asset at a certain price and are commonly used when expecting rising prices.

By comparing the volume or open interest of puts to calls, the PCR provides a quick snapshot of how market participants are positioning themselves.

In simple terms:

• A higher PCR (>1) means more puts than calls are being traded, suggesting bearish sentiment.

• A lower PCR (<1) means more calls than puts are being traded, suggesting bullish sentiment.

Why PCR Matters

The PCR matters because it is one of the clearest gauges of market sentiment. Traders and analysts use it to understand whether the majority of the market is fearful, cautious, or optimistic:

• Market Sentiment Insight: PCR reflects the balance between bearish and bullish bets, offering a real-time indicator of crowd psychology.

• Contrarian Signals: Extremely high or low PCR values can act as contrarian signals. For example, if most traders are bearish (very high PCR), it could mean the market is near a bottom and due for a rebound.

• Risk Assessment: PCR helps traders identify when market sentiment is too one-sided, which often increases the risk of sharp reversals.

While PCR is not a stand-alone tool, it becomes especially powerful when combined with other indicators and technical analysis. It gives traders a way to measure not just price movements, but the emotions and expectations driving those moves.

PCR Formula & How to Calculate It

The Put-Call Ratio is calculated using a straightforward formula:

Depending on the data source, the calculation can be based on either:

• Options Volume → the total number of contracts traded during a given time period.

• Open Interest → the total number of outstanding contracts that remain open at the end of the trading day.

Both methods are common, but the interpretation may differ slightly:

• Volume-based PCR shows immediate sentiment for the day.

• Open-interest PCR reflects longer-term positioning in the market.

Example Calculation of PCR:

Let’s take a simple example:

• Total Put Options traded in a day: 120,000

• Total Call Options traded in a day: 80,000

Interpretation: A PCR of 1.5 means there were 1.5 times more puts traded than calls. This suggests that traders were more focused on downside protection or bearish bets, signaling a cautious or negative market sentiment.

For comparison:

• If PCR = 0.7, it means calls outnumber puts, showing bullish sentiment.

• If PCR = 1.0, puts and calls are equal, indicating balanced sentiment.

Interpreting Put-Call Ratio Values

To make the most of PCR, it’s important to understand how different values reflect shifts in market sentiment.

Low PCR (<1)

A low PCR, typically below 1, means that more call options are being traded than put options. This suggests that traders are optimistic and expect prices to rise.

• Market Sentiment: Bullish, as investors are betting more heavily on the upside.

• Trader Behavior: Higher demand for calls shows confidence in growth, rallies, or upward momentum.

• Caution: Extremely low PCR values can indicate excessive optimism, which sometimes precedes market pullbacks.

Example: If PCR = 0.6, this means calls outnumber puts, showing strong bullish sentiment.

High PCR (>1)

A high PCR, above 1, indicates that more puts are being traded than calls. This is generally seen as a sign of bearish sentiment, where traders expect prices to fall or are seeking downside protection.

• Market Sentiment: Bearish, as investors prepare for potential declines.

• Trader Behavior: High put activity often reflects fear, hedging, or defensive positioning.

• Caution: A persistently high PCR can suggest that bearish sentiment is overstretched, which might lead to a rebound.

Example: If PCR = 1.3, it shows that put trading volume is 30% higher than call volume, suggesting a cautious or bearish outlook.

Extreme PCR Values

Extreme PCR readings, whether very high or very low, are often viewed as contrarian signals by traders.

• Extremely Low PCR (e.g., <0.5):

  • Indicates overwhelming bullishness.

  • Can be a warning sign of an overheated market.

  • May precede short-term corrections.

• Extremely High PCR (e.g., >1.5 or 2.0):

  • Indicates heavy bearishness or panic.

  • Can signal that the market is oversold.

  • May precede a short-term rebound or relief rally.

In short, extreme PCR values are often less about confirming current sentiment and more about spotting when sentiment has become too one-sided, conditions that often lead to market reversals.

Using PCR in Trading Strategies

Once traders understand how to read PCR values, the next step is learning how to apply them in real trading strategies.

Contrarian Trading Strategy

One of the most common ways traders use PCR is as a contrarian indicator. The idea is simple: when market sentiment becomes too extreme, it often signals that a reversal may be near.

• Extremely High PCR (>1.5): Suggests excessive bearishness. Contrarian traders may interpret this as a sign the market is oversold and due for a bounce.

• Extremely Low PCR (<0.5): Suggests excessive bullishness. This can be a warning that the market is overbought and may face a pullback.

In practice, contrarian traders use PCR not to follow the crowd, but to anticipate when the crowd has gone too far in one direction.

Combining PCR with Other Indicators

While PCR provides insight into sentiment, it should not be used in isolation. Traders often combine it with technical and fundamental analysis to improve accuracy:

• Technical Indicators: Moving averages, RSI, MACD, and Bollinger Bands can help confirm whether sentiment signals from PCR align with price trends.

• Market Breadth Indicators: Data like the advance-decline line or volatility index (VIX) can strengthen conviction in a trade.

• Volume and Price Action: Observing whether trading volume and price movements support PCR signals adds another layer of confirmation.

By combining PCR with other tools, traders reduce the risk of acting on false signals.

Risk Management with PCR

PCR can also support risk management by helping traders adjust exposure based on sentiment conditions.

• High PCR (Bearish Sentiment): Traders may choose smaller position sizes or hedge with protective strategies, such as stop-loss orders or buying puts.

• Low PCR (Bullish Sentiment): Traders may take profits earlier or tighten stop-losses, recognizing that excessive optimism can lead to sudden reversals.

• Extreme PCR Values: Encourage caution, as these often coincide with volatile turning points in the market.

Ultimately, PCR is most effective when treated as a guidance tool, a way to manage risk and sentiment exposure, rather than a signal to trade on its own.

Limitations of PCR

While the Put-Call Ratio is a valuable sentiment indicator, it is not without its drawbacks. Traders should be aware of its limitations before relying on it for decision-making:

• Not a Stand-Alone Tool: PCR reflects sentiment but does not provide direct buy or sell signals. On its own, it can lead to misleading conclusions if market context is ignored.

• Different Interpretations: A PCR of 1.2 may be considered bearish in one market environment but normal in another. Without considering broader conditions, traders risk misinterpreting signals.

• Market-Specific Differences: PCR values vary depending on the asset class (stocks, indices, commodities, or currencies). A “high” PCR for one market may be average for another.

• Time Sensitivity: Volume-based PCR gives only short-term sentiment, while open-interest-based PCR reflects longer-term positioning. Using the wrong type may distort analysis.

• False Extremes: Extreme PCR values can sometimes persist for long periods without leading to a reversal. Markets can remain bullish or bearish longer than expected, making contrarian trades risky.

Conclusions

The Put-Call Ratio (PCR) is a simple yet powerful indicator that provides insight into market sentiment by comparing the trading activity of puts and calls. By learning how to calculate it, interpret its values, and apply it within trading strategies, traders can gain a clearer view of whether the market mood is leaning bullish, bearish, or reaching an extreme.

However, PCR is not a crystal ball. Its readings can be influenced by hedging activity, market conditions, and the type of data used (volume vs. open interest). For this reason, PCR should always be combined with other technical and fundamental tools to build a more reliable trading outlook.

Note: The Put-Call Ratio (PCR) is a market sentiment indicator and should be used in conjunction with other analysis tools. Please note that XS.com does not provide facilities for trading put or call options. We offer a suite of other powerful trading tools for the instruments available on our platform.