I read about the put-call ratio where it says that the ratio can be used as a parameter to check whether the market is bearish or bullish. However, the reason given for the same is that, “The higher than average number indicates more puts being bought relative to calls. This means that more traders are betting against the underlying and hence the general outlook is bearish. Conversely, when the ratio is near 0.50 or lesser, it implies a bullish sentiment.”
But, for every person who buys a put option, with the belief that the market will fall, there is a person selling/writing that put, who believes the market will rise. So, I believe the put-call ratio does not give any insight into the market sentiment
The put-call ratio is a popular tool specifically designed to help individual investors gauge the overall sentiment (mood) of the market. The ratio is calculated by dividing the number of traded put options by the number of traded call options.
As per my knowledge, it is believed that option writer are more risk taker and institutional, more informed and market prefer their sentiment so when put call ratio is .5 means option writer writing less put than call Hence they are bullish.
The Put Call ratio gives an idea of traders’ sentiments. For PCR higher than 1, a bearish mood is indicated. For PCR values lower than 0.7, a bullish mood is indicated. However, the ratio is more often used as a contrarian indicator. A PCR value of lower than 0.6, will indicate an imminent bearish reversal(the logic being that when there are too many call buyers, there will be some point of time when long calls will be liquidated and the market will crash). Similarly, a PCR value of higher than 1.6 will indicate an imminent relief rally(due to short covering) resulting in a price surge.