What Is a Put-to-Call Ratio? Definition & Interpretation

Options contracts are derivative securities that give their owners the right to buy or sell a stock at a specified strike price on or before a certain expiration date. Put options allow their owners to sell stocks at the strike price, while call options allow their owners to buy stocks at the strike price.

Call options are considered bullish because they go up in value when the underlying stock goes up in price, while put options are considered bearish because they go up in value when the underlying stock goes down in price.

What Is a Put-to-Call Ratio?

A put-to-call ratio (also written as put-call or put/call) is a sentiment indicator that compares put-option trading volume to call-option trading volume over a certain period of time (usually a single trading day). If more put options were sold, the ratio will be 1 or higher, while if more call options were sold, the ratio will be below 1.

Put-to-Call Ratio Formula

PC Ratio = Put Option Volume / Call Option Volume

What Do High & Low Put/Call Ratios Mean? Why Are They Important?

Put-to-call ratios can be calculated for individual stocks or stock funds, which comprise many different stocks and can be composed to represent an industry within the market or the market at large.

The higher a put/call ratio is, the more bearish or pessimistic the market is toward the stock (or fund) in question. In other words, investors are betting the underlying asset will go down in price in the near future.

The lower a put/call ratio is, the more bullish or optimistic the market is toward the asset. In other words, investors are betting the underlying asset won’t go down in price in the near future.

Put-to-call ratios are important technical indicators because they provide insight into the market’s sentiment toward a particular stock, industry, or the stock market at large. Shorter-term, higher-frequency traders in particular can look at changes in put-call ratios on a day-to-day basis and make buy and sell decisions based on shifts in market sentiment.

How to Interpret a Put-to-Call Ratio

When interpreting put-to-call ratios as a measure of market sentiment, it’s important to keep in mind what puts and calls actually represent. In many cases, calls are bullish bets that an asset will go up in price, and puts are bearish bets that an asset will fall in price.

Puts and calls, however, are also commonly used to hedge existing long or short positions. For instance, an investor with a long position in stock XYZ (i.e., they own shares in stock XYZ and expect it to go up in price) may also buy put options on the stock to help them recoup some of their losses should Stock XYZ fall in price. In this case, the Stock XYZ bull would be contributing to the put side of the put/call ratio, but not because they are bearish on the stock.

In other words, put-call ratios should be taken with a grain of salt and examined alongside other sentiment indicators, such as short interest, to get a fuller picture of where an asset stands in the eyes of investors.

Another important caveat to keep in mind when looking at put/call ratios is that, in general, calls are purchased more than puts, so a ratio of 1 (indicating an equal number of puts and calls sold) doesn’t necessarily mean the market is ambivalent about the asset in question. In general, a ratio of about 0.7 is considered normal for a stock that the market is neither bullish nor bearish about. A ratio of 1, therefore, would be somewhat bearish.

Finally, a single put/call ratio represents a single-day snapshot of the market sentiment toward an asset or fund, but changes in a put/call ratio over time can be even more informative, as a steadily rising or falling ratio can represent a shift toward bullish or bearish sentiment, respectively. On the other hand, an asset’s ratio can change drastically from one day to the next, typically due to the release of some new information, like a disappointing earnings report or a piece of federal infrastructure legislation that is likely to be a boon to a company’s revenue.

For a Stock

Interpreting the put/call ratio of a stock is fairly straightforward. Using 0.7 as a benchmark, an investor can get a snapshot of whether market sentiment is bullish or bearish and to what degree. Moreover, watching a stock’s ratio change steadily over time (or suddenly and drastically) can provide insight into whether that stock’s sentiment is gaining momentum in one direction or the other.

For an Industry

To use a put/call ratio to gauge market sentiment toward an entire industry (clean energy, for instance), an investor could identify one or more exchange-traded funds composed to represent that industry. In the case of the clean energy industry, iShares Global Clean Energy UCITS ETF is a popular choice. By examining the put/call ratio for this fund in the same way as they would for a single stock, an investor could monitor market sentiment toward renewable energy companies in general.

For the Stock Market at Large

To gauge total market sentiment, an investor could use the same process above but select a total market fund like the Vanguard Total Stock Market Index Fund ETF. Here, a put/call ratio could be used alongside other total market sentiment indicators like the VIX, the Daily Sentiment Index, the Fear and Greed index, and the Buffet Indicator.