In Summary: High PCR means the market is bullish because the option writers are inclined to write puts. Low PCR means bearish sentiment – because option writers are not willing to write puts but instead write calls.
The put-call ratio (PCR) is a popular tool specifically designed to 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 this ratio increases, it can be interpreted to mean that the investors are putting their money into put options rather than call options. An increase in traded put options signals that investors are either starting to speculate that the market will move lower, or starting to hedge their portfolios in case of a sell-off.
The put-call ratio (PCR) is primarily used by traders as a contrarian indicator when the values reach relatively extreme levels. This means that many traders will consider a large ratio a sign of a buying opportunity because they believe that the market holds an unjustified bearish sentiment and it will adjustto normal soon, once the short covering begins.
Unfortunately, there is no magic number that indicates that the market has created a bottom or a top, but generally traders will anticipate this by looking for spikes in the ratio or for when the ratio reaches levels that are outside of the normal trading range.
An increasing ratio is a clear indication that investors are starting to move toward instruments that gain when prices decline rather than when they rise. Since the number of call options is found in the denominator of the ratio, a reduction in the number of traded calls will result in an increase in the value of the ratio. This is significant because the market is indicating that it is starting to dampen its bullish outlook.
Regarding Nifty Open Interest, it provides good support and resistance levels for the series. Traders usually look for Nifty Open interest highest OI strikes. These strikes are important to determine support and resistance.
Because Option Writers are generally market players with deeper pockets compared to option buyers.
Open Interest analysis can provide very useful insights pertaining to market trend and support/resistance. It is very important for options traders to understand the relation between open interest and market direction. Combining interpretations from Open Interest (OI) and change in OI can give meaningful results. Intelligent traders understand that even though Option Chain Open Interest of Nifty is a very crucial ‘market indicator’, it should be combined with other technical indicators to generate profitable trades.
Using Nifty Option Chain table, the Open Interest data can give very useful clues to determine Support and Resistance. e.g. if 6000PE has the highest open interest, traders perceive it as important support for the current expiry. Keeping in view that most institutional investors write options rather than buy, the data helps to understand the sentiment of ‘intelligent money’. Similarly, if huge open interest is build for 6200 calls it will be seen as major resistance zone. Close to expiry, the market may stay range-bound between these two levels.
|Increase in Price||Increase in Open Interest||Indication of new money coming and indicates further continuance of uptrend|
|Increase in Price||Decrease in Open Interest||Increase in price is due to short covering of positions|
|Decrease in Price||Increase in Open Interest||Decrease in price is due to newly build short positions and further weakness is predicted|
|Decrease in Price||Decrease in Open Interest||Traders unwinding their long positions by selling existing contracts|
While the first and third scenarios of interpretation of open interest charts indicate the direction of future market trend (Bullish in the first case and Bearish in the third Case), other scenarios do not indicate a clear trend. Traders can wait for clarity in open interest data or use other indicators to initiate positions.