Derivatives

Can PCR be used to gauge support, resistance levels?

Akhil Nallamuthu | Updated on April 10, 2021

I read somewhere that since most call options are sold by large institutions, they act as resistance. Hence if calls are higher than puts (for example PCR < 0.7) then it is bearish. Kindly clarify.

- Vijay K

Selling options requires higher margins and the ability to take more risks as theoretically the loss is unlimited for a limited profit which one receives as the premium. In that sense, selling of options, not just call options but also put options are generally done by sophisticated participants such as large institutions and high net worth individuals. By this logic, calls and puts with highest open interest (OI) are assumed to act as resistances and supports, respectively.

However, this is not a given and this logic can fail. As the market dynamics vary, these large institutions might change their view and may take fresh positions or modify existing trades accordingly. Also, we should remember that large investors and traders will generally implement multi-legged strategies. This means rather than buying or selling plain-vanilla call or put options, they can go for a combination of both and there is no limit to the ways in which such strategies can be designed and executed.

So, as traders, one should always track how put-call ratio (PCR) changes over time, rather than looking at it on one particular day. For instance, one should see how the PCR varies and in what direction the market has been moving over a two-week period. Suppose if PCR has been declining and the market is up, it is a bullish signal irrespective of who buys or sells options.

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Published on April 10, 2021

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