Put-call Ratio Research Articles

The information content of option ratios

A broad stream of research shows that information flows into underlying stock prices through the options market. For instance, prior research shows that both the Put–Call Ratio (P/C) and the Option-to-Stock Volume Ratio (O/S) predict negative future stock returns. In this paper, we compare the level of information contained in these two commonly used option volume ratios. First, we find that P/C ratios contain more predictability about future stock returns at the daily level than O/S ratios. Second, in contrast to our first set of results, O/S ratios contain more predictability about future returns at the weekly and monthly levels than P/C ratios. In fact, our tests show that while P/C ratios contain predictability about future daily returns and, to some extent, future weekly returns, the return predictability in P/C ratios is fleeting. O/S ratios, on the other hand, significantly predict negative returns at all levels: daily, weekly, and monthly. While Pan and Poteshman (2006) show that signed P/C ratios, which require proprietary data, have predictive power, we find that unsigned P/C ratios, which do not require proprietary data, also have predictive power.

The Information Content of Option Ratios

A broad stream of research shows that information flows into underlying stock prices through the options market. For instance, prior research shows that both the Put-Call Ratio (P/C) and the Option-to-Stock Volume Ratio (O/S) predict negative future stock returns. In this paper, we compare the level of information contained in these two commonly used option volume ratios. Our comparison of the return predictability contained in these ratios yields some new results. First, we find that P/C ratios contain more predictability about future stock returns at the daily level than O/S ratios. Second, in contrast to our first set of results, O/S ratios contain more predictability about future returns at the weekly and monthly levels than P/C ratios. In fact, our tests show that while P/C ratios contain predictability about future daily returns and, to some extent, future weekly returns, the return predictability in P/C ratios is fleeting. O/S ratios, on the other hand, significantly predict negative returns at both the weekly and monthly levels, respectively.

The Substitutability between Short Sales and Bearish-Option Activity

Prior research argues that pessimistic traders can use options as substitutes for short sales particularly when stocks are expensive to short. We test this hypothesis and find that (i) put-call ratios are inversely related, instead of directly related, to proxies for short-sale constraints and (ii) the significant negative relation between current put-call ratios and future returns (Pan and Poteshman, 2006) is orthogonal to proxies for short-sale constraints. These results indicate that short-sale constraints do not influence bearish option activity. While prior studies show that short sellers are generally contrarian in contemporaneous and past returns, we find that put-call ratios follow periods of negative returns. However, any observed return predictability contained in put-call ratios is driven by ratios that follow periods of positive returns.

Measures Of Investor Sentiment: A Comparative Analysis Put-Call Ratio Vs. Volatility Index

<p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="font-size: 10pt;"><span style="font-family: Times New Roman;">Traditional research on asset pricing has focused on firm-specific and economy-wide factors that affect asset prices.<span style="mso-spacerun: yes;">  </span>Recently, the finance literature has turned to non-economic factors, such as investor sentiment, as possible determinants of asset prices (see for example, Fisher and Statman 2000 and Baker and Wurgler 2006).<span style="mso-spacerun: yes;">  </span>Studies such as Baek, Bandopadhyaya and Du (2005) suggest that shifts in investor sentiment may explain short-term movements in asset prices better than any other set of fundamental factors.<span style="mso-spacerun: yes;">  </span>A wide array of investor sentiment measures are now available, which leads us quite naturally to the question of which measure best mirrors actual market movements.<span style="mso-spacerun: yes;">   </span>In this paper, we begin to address this question by comparing two measures of investor sentiment which are computed daily by the Chicago Board Options Exchange (CBOE) and for which historical data are freely available on the CBOE website, thus making them ideal for use by both academics and practitioners studying market behavior: the Put-Call Ratio (PCR) and the Volatility Index (VIX).<span style="mso-spacerun: yes;">  </span>Using daily data from January 2, 2004 until April 11, 2006, we find that the PCR is a better explanatory variable than is the VIX for variations in the S&P 500 index that are not explained by economic factors.<span style="mso-spacerun: yes;">  </span>This supports the argument that, if one were to choose between these two measures of market sentiment, the PCR is a better choice than the VIX.</span></span></p>

Trading Puts and CDS on Stocks with Short Sale Ban

We focus on the short sale ban of 2008 to examine the interaction between the price discovery in banned stocks and the trading of options and CDS. Within the sample of banned stocks with exchange traded options, stocks whose put-call ratios are in the top quintile underperform the middle group by 2.13% and 4.01% over the next three- and five-day returns, respectively. By contrast, the bottom quintile does not perform differently from the middle group. Within the sample of banned stocks with CDS traded and using their one-day percentage change in CDS spreads as a signal, we find cross-sectional predictability of CDS signal for future stock returns. Again, the predictability is asymmetric, driven mostly by stocks with more positive percentage change in CDS spreads, and therefore more negative information according to the CDS market. Overall, our results confirm that in the presence of short sale ban, it takes time for the negative information contained in either the options market or the CDS market to get incorporated into stock prices.

Time Variation in Analyst Optimism: An Investor Sentiment Explanation

Many studies have documented that analyst forecasts are overly optimistic on average. Using quarterly observations from 1984 to 2002, this article shows that forecasts exhibit optimism for most of the quarters under examination, but the level of optimism varies substantially over time. More important, after correcting the measurement problem caused by price, this article does not find optimism greatly diminished during most of the 1990s. However, consistent with previous findings, the period of 1999 to 2000 displays pessimistic forecasts, especially for large firms and growth firms. The macroeconomic factor does not have significant impact on analyst optimism. In contrast, the time-varying investor sentiments measured by 2 Chicago Board Options Exchange (CBOE) put-call ratios, and the cross-sectional skewness in the forecast errors, play an important role in explaining the time variation in analyst optimism. Finally, analysts track institutional investor sentiment more closely, except for small firms.

Are Investment Strategies Exploiting Option Investor Sentiment Profitable? Evidence from Japan

This paper demonstrates that the put–call ratio (PCR), an index of option investor sentiment, is useful for equity investment. More specifically, we find that monthly market timing strategies for the Nikkei 225 using the PCRs of Nikkei 225 index options are profitable, even after considering transaction costs. This evidence suggests that the PCR operates as a useful contrarian indicator for the underlying asset in Japan. Our analysis also reveals that application of the multivariate GARCH model in Japan is effective in predicting changes in the Nikkei 225 using the level of PCR.

Investor Sentiment in India: A Survey

In this paper we examine definitional aspect of Investor Sentiment, the key economic, market and regulatory factors that influence investor sentiment and the relationship between investor sentiment and market performance. There seems to be no clear consensus on the concept of investor sentiment and hence any meaningful definition ought to be inclusive and fluid. The important economic factors highlighted in the work are: Real GDP, Corporate Profits, Rate of Inflation, Level of Interest Rate, and Liquidity in the Economy. The market based factors that can be linked to Investor Sentiment are: Put Call Ratio, Advance Decline Ratio, Earning Surprises, P/E Ratio, and Price to Book Value. The regulatory framework of a financial market does seem to have a strong bearing on investor sentiment especially the legal provisions relating to corporate governance and Grievance Redressal Mechanism. Most respondents believe that investor's sentiment and market returns are bilaterally co-related. Our findings are largely in conformity with recent studies for other capital markets. These findings can be used to develop a comprehensive Investor Sentiment Index for India and hence have significant implications for investors, market intermediaries and financial regulators.

Option volume, strike distribution, and foreign exchange rate movements

Using Deutschmark currency option data from the Philadelphia Stock Exchange and British pound option data from the Chicago Mercantile Exchange, this article examines the signaling quality of option volume measures on movements in the underlying spot exchange rates. The concept of a volume-weighted strike distribution is proposed. It is demonstrated that measures using the strike distribution are inherently better predictors of both direction and volatility of the exchange rate movements as compared to their more traditional counterparts used in practice, such as the put-call ratio.

The Information in Option Volume for Future Stock Prices

We present strong evidence that option trading volume contains information about future stock prices. Taking advantage of a unique data set, we construct put-call ratios from option volume initiated by buyers to open new positions. Stocks with low put-call ratios outperform stocks with high put-call ratios by more than 40 basis points on the next day and more than 1% over the next week. Partitioning our option signals into components that are publicly and nonpublicly observable, we find that the economic source of this predictability is nonpublic information possessed by option traders rather than market inefficiency. We also find greater predictability for stocks with higher concentrations of informed traders and from option contracts with greater leverage.

Individual Investor Sentiment and Stock Returns - What Do We Learn from Warrant Traders?

In this paper, we propose a measure of individual investor sentiment that is derived from the market for bank-issued warrants. Due to a unique warrant transaction data set from a large discount broker we are able to calculate a daily sentiment measure and test whether individual investor sentiment is related to daily stock returns by using vector autoregressive models and Granger causality tests. Our sentiment measure should be, ex ante, the preferred measure when compared to other sentiment measures proposed in the literature that are based on the closed-end fund discount, stock market transactions, the put-call ratio or investor surveys as it circumvents problems that are associated with the measures used in prior studies. We find that there exists a mutual influence between sentiment and stock market returns, but only in the very short-run (one and two trading days). Returns have a negative influence on sentiment, while the influence of sentiment on returns is positive for the next trading day. The influence of stock market returns on sentiment is stronger than vice versa. Our results cast doubt on whether sentiment measures are useful to predict the market over horizons of more than one day. Even our improved measure is hardly able to do so. Nevertheless, sentiment measures provide evidence on how investors trade and which factors influence their expectations.

When do Value Stocks Outperform Growth Stocks? Investor Sentiment and Equity Style Rotation Strategies

This paper investigates a relation between investor sentiment and performance of value stocks over growth stocks. To measure noise investors' sentiment, we use gauges: the CBOE equity put-call ratio and the market volatility (VIX) index. We find that value stocks tend to outperform growth stocks when the CBOE equity put-call ratio is relatively low or the VIX is relatively high. When the put-call ratio is relatively high or the VIX is relatively low, however, growth stocks marginally outperform or perform as well as value stocks. This finding suggests that the return premium of value stocks over growth stocks is at least partially influenced by investor sentiment. A strategy that switches equity styles on the basis of the put-call ratio seems to beat the benchmarks.