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Put/Call Ratio

The Put/Call ratio is calculated by dividing the volume of put option contracts by the volume of call option contracts. This ratio is calculated by the Chicago Board Options Exchange (CBOE).

A 10-day moving average is often used to smooth out the rapid changes in this ratio.

When the market is very bullish, the volume of call options will be much larger than the volume of put options, because traders are optimistic about future price movements. The Put/Call Ratio may be around 0.6. Many traders anticipate a downtrend at this level because bullishness has gotten to an extreme level.

When the market attitude is neutral, the Put/Call Ratio is around 0.8. There is a natural tendency for more calls to be sold than puts.

When the market is very bearish, the volume of call options will be smaller than the volume of put options, because traders are optimistic about future price movements. The Put/Call Ratio may be around 1.1. Many traders anticipate a new uptrend when the Put/Call Ratio rises above 1.0 because bearishness has gotten to an extreme level.

The Put/Call ratio is a sentiment indicator, so it gives an indication of the level of bullishness or bearishness in the market. Sentiment indicators are interpreted in a contrarian sense, so it indicates a reversal of trend. When there is extreme bullishness, it warns of a downturn in the market. Similarly, when there is extreme bearishness, it is interpreted as a precursor to an upturn in the market.

This Indicator can be used in conjunction with the McClellan Oscillator or the Arms Index as further confirmation of an indicated trend reversal.

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