Understanding Put/Call Ratios

By:

Chief Strategist at Interactive Brokers

I got a series of questions yesterday about the elevated put/call ratio. I must admit, they caught me by surprise. The put/call ratios that I watch – there are several – showed no drama. Here’s the problem – there are many different put/call ratios that one can use, and the one being discussed isn’t that useful. As a result, I thought it seemed like a ripe topic to discuss today.

First of all, let’s remember exactly what a put/call ratio is and what, if any, significance it may have.  The ratio is actually quite self-descriptive. We take the total volume of puts traded on a given day and divide it by the total volume of calls traded on that day. That’s it. What the ratio hopes to measure is extremes in sentiment and is typically viewed as contrarian indicator. If too many puts trade relative to calls, then we might be at a bearish extreme. Conversely, if too many calls trade relative to puts, there might be too much optimism.  

Some well-known market commentators posted a chart showing an extreme reading in the CBOE equity put/call ratio on social media yesterday. It looked something like this, with the ratio at an all-time high:

CBOE Equity Put/Call Ratio, 1-Year Daily Chart

CBOE Equity Put/Call Ratio, Dec-21 – Nov-22

Source: Bloomberg

That jump is certainly eye-catching. We see three successively higher spikes in the ratio through Wednesday. The obvious explanation seems ominous, that there has been a mad rush for puts over the past few days. The actual explanation is a bit more subtle and a lot less dire.

The ratio used in the social media posts was specifically focused on options volume on the Cboe. The Cboe is the largest US options exchange, but it is just one of 16! It seems silly to focus on just one of 16 potential places where options trade. Let’s say there was one large vertical put spread that happened to trade on the CBOE. That would tell you very little. Yes, it would inflate put volume tremendously, but a delta-neutral trade of that type tells us nothing about bullish or bearishness.

For these reasons, I prefer to do two things. First, I focus on the total options volume across all exchanges. There are too many vagaries that influence order routing; I prefer to remove them from the data. Second, I prefer to use moving averages to analyze the data. When daily readings are as disjointed as we see in the graph above, it is quite helpful to smooth them with a moving average. Consider the following graph:

US Put/Call Ratio Composite (white), Cboe Equity Put/Call Ratio (yellow), with 21-Day Moving Averages (magenta, green), 1-Year Daily Data

US Put/Call Ratio Composite, Cboe Equity Put/Call Ratio, with 21-Day Moving Averages, Dec-21 – Nov-22

Source: Bloomberg

The white line shows the put/call ratio using total options volume across all US options exchanges, and the magenta line is its 21-day moving average. This is a much more comprehensive measure. It is modestly elevated, but far from extreme levels. We see none of the extremes that are shown in the yellow line, which is the Cboe equity put/call ratio. It appears that there is something specific to the Cboe that is influencing their data.

One suspect could be that the Cboe recently got approval to list daily expirations on SPY and QQQ. Options volumes have been increasing moving toward shorter expiries, and these are two of the most actively traded options classes. It is quite possible that intra-day speculation in those exchange-specific options (for now) has an undue influence on the Cboe-specific put/call ratio.

With 16 exchanges, and the ability to differentiate between equity, index and ETF options, there are myriad ways to look at put/call ratios. Some of them would obviously be too narrow to be useful, and I’ll argue that the popular Cboe equity put/call ratio is one. Heck, what really distinguishes the Cboe from its peers is its unique license for S&P Index products. It seems odd to ignore their bread and butter products.

Bottom line, put/call ratios can be very useful for options trading, but you need to be careful which data you’re using. I’ve found them to be useful contrarian indicators, but more explanatory than predictive. Extreme readings, particularly when they are sustained long enough to influence moving averages, can indeed be a cause to consider whether a turning point may be in the offing, but a few high readings in a very specific ratio does not appear to be a reason for significant hand wringing on social media.

Postscript: For some historical perspective, here is a 5-year chart of the above data.  Notice how depressed the put/call ratio was during 2021 when call speculation was rampant, and that current levels are consistent with the pre-Covid years:

US Put/Call Ratio Composite (white) with 21-Day Moving Average (magenta), 5-Year Daily Data

US Put/Call Ratio Composite with 21-Day Moving Average, 2018 – 2022

Source: Bloomberg

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