Put-call ratio in the Indian context

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Markets are sentiment-driven and a put/call ratio (PC ratio) is simply a popular sentiment indicator. Bullishness is greed driven and bearishness is fear driven. The one bullish on the market buys a call option and the one bearish on the market buys a put option. PC ratio is the number of put options divided by number of call options. This ratio tells us about the level of bullishness or bearishness in the market. PC ratio can be used in two ways, either the direct way or the contrarian way. For the direct way, you simply follow the ratio and flow with the tide, and for the contrarian way when bullishness is high then downside risk is also high so you take a contrarian view and sell or vice versa. It can act as a preventive measure against sentiments which often lead to buying when the market is high and selling when it is low.

PC ratio goes well with overbought and over sold indicators. A low PC ratio, generally below one, reflects a bullish sentiment and vice versa. It can be based either on open interest or volumes. PC ratio on volumes indicates the sentiment on that particular day while PC ratio on open interest (PCR-OI) gives a carry forward view.

Open interest is the total number of options and/or futures contracts that have not yet been exercised, expired or fulfilled by delivery on a particular day. PCR-OI is mainly used to gauge the sentiment for the coming trading sessions.

Theoretically, if one buys a put option then he is bearish on the underlying and one who buys a call option is bullish on the same. This theory works very well in matured markets where options turnover as well as open interest is significantly high. So there, one can form a conclusion that if PCR-OI is high then market participants are expecting underlying to correct and vice-versa. However, PCR-OI is not seen in isolation, it is seen with price movement. For example, if underlying after moving up has become range-bound and then you see that PCR-OI of that underlying is increasing then one may say that participants are expecting correction and vice-versa.