The Put/Call ratio is used as an indicator to measure the sentiment of the more speculative investors. When the Put/Call Ratio is high (meaning more puts are being traded than calls) it means that the sentiment is bearish. The rising pessimism of the more speculative investors has historically been ill rewarded by the market turning upward. The Put/Call ratio moves lower as the level of buying Puts moves lower in relation to the buying of Calls indicating that the level of optimism of the options buyers is moving up. As option buyers become more optimistic the market will start to move downward.
When the Ratio is in the range of over 70% it is an indication that a rally will soon take place. Rally peaks often take place when the ratio is at or near the 35-40% range. Another formation to look for is when the Put/Call ratio makes a reversal from either extreme, over 70% or under 40%. This reversal has a high percentage of being a good signal of a short term spike of the market.
This indicator is calculated by using a 5 day average on the CBOE Call Volume (entered as volume per 1000 in the closing price field of their respective files) and the CBOE Put Volume.
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