understanding open-interest and put-call ratio

imagine there are 100 traders in a hall

a game is played

the referee asks all of them

"those who believe the market is going to go up tomorrow

pl come to my left.

and those who believe the market is going to go down tomorrow

pl come to my right."

--

out of 100

12 go to left

they are having bullish view about the market

and prepared to buy call options!

--

and 8 go to right

they are having bearish view about the market

and prepared to buy put options!

--

rest 80

are neutral

and want to stay out of trade.

--

so, we can say

that the open interest is 20

and the put/call ratio is

8/12 = 0.66

--

next day

the market closes way up.

the meeting of 100 traders

is called again.

the referee says the same thing

"those who believe the market is going to go up tomorrow

pl come to my left.

and those who believe the market is going to go down tomorrow

pl come to my right."

all 12 who were bullish yesterday

are incidentally

still bullish

and come to the referee's left!

rather 6 more join them

after seeing the market sentiments!

so, now

there are 18 traders on the bullish side

who are willing to buy calls.

on the opposite side

instead of 8

only 4 turn up

who are still bearish

and willing to buy puts!

so, today

the open interest is 18+4=22

up 2 from yesterday's 20!

and the put/call ratio today is

4/18 = 0.22!



so, while the open interest has gone up

the put-call ratio has gone down!

interpreting change in open interest

when a stock falls on increase in open interest, go short

when a stock rises on increase in open interest, go long

when a stock falls on decrease in open interest, unwind long but wait for shorting

when a stock rises on decrease in open interest, cover shorts but wait for going long

if you couple this information with put/call ratio, the results can be amazing!