PCR & NIFTY VIX Understanding & Trading with Sentiment Indicators. Using PCR & VIX Practically - I

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Created by the Chicago Board Options Exchange (CBOE), the Volatility Index, or VIX, is a real-time market index that represents the market's expectation of 30-day forward-looking volatility. Derived from the price inputs of the S&P 500 index options, it provides a measure of market risk and investors' sentiments. It is also known by other names like "Fear Gauge" or "Fear Index." Investors, research analysts and portfolio managers look to VIX values as a way to measure market risk, fear and stress before they take investment decisions.
For financial instruments like stocks, volatility is a statistical measure of the degree of variation in their trading price observed over a period of time. Volatility can be measured using two different methods. First is based on performing statistical calculations on the historical prices over a specific time period. This process involves computing various statistical numbers, like mean (average), variance and finally the standard deviation on the historical price data sets. The resulting value of standard deviation is a measure of risk or volatility. In spreadsheet programs like MS Excel, it can be directly computed using the STDEVP() function applied on the range of stock prices. However, standard deviation method is based on lots of assumptions and may not be an accurate measure of volatility. Since it is based on past prices, the resulting figure is called “realized volatility” or "historical volatility (HV)." To predict future volatility for the next X months, a commonly followed approach is to calculate it for the past recent X months and expect that the same pattern will follow.
The second method to measure volatility involves inferring its value as implied by option prices. Options are derivative instruments whose price depends upon the probability of a particular stock’s current price moving enough to reach a particular level (called the strike price or exercise price). For example, say IBM stock is currently trading at a price of $151 per share. There is a call option on IBM with a strike price of $160 and has one month to expiry. The price of such a call option will depend upon the market perceived probability of IBM stock price moving from current level of $151 to above the strike price of $160 within the one month remaining to expiry. Since the possibility of such price moves happening within the given time frame are represented by the volatility factor, various option pricing methods (like Black Scholes model) include volatility as an integral input parameter. Since option prices are available in the open market, they can be used to derive the volatility of the underlying security (IBM stock in this case). Such volatility, as implied by or inferred from market prices, is called forward looking “implied volatility (IV).”

Though none of the methods is perfect as both have their own pros and cons as well as varying underlying assumptions, they both give similar results for volatility calculation that lie in a close range.
One way to calculate PCR is by dividing the number of open interest in a Put contract by the number of open interest in Call option at the same strike price and expiry date on any given day.

PCR (OI) = Put open interest on a given day/Call open interest on the same day

It can also be calculated by dividing put trading volume by call trading volume on a given day.

PCR (Volume) = Put trading volume/call trading volume

PCR for marketwide positions can also be calculated by taking total number of OI for all open Call options and for all open Put options in a given series.
A PCR ratio below 1 suggests that traders are buying more Call options than Put options. It signals that most market participants are betting on a likely bullish trend going forward. For contrarians, it is a signal to go against the wind.

On the flip side, if the ratio is higher than 1, it suggests traders are buying more Puts than Calls. Unlike Call options, Put options are not initiated just for directional call. They are bought also to hedge against any decline in the market.

The market sentiment is deemed excessively bearish when the PCR is at a relatively high level. But for contrarian investors, it suggests that the market may soon bottom out. On the other hand, when the ratio falls to a relatively low level, it is deemed excessively bullish. For contrarians, it would suggest a market top is in the making.

The PCR can be calculated for indices, individual stocks and for the derivative segment as a whole.

Видео PCR & NIFTY VIX Understanding & Trading with Sentiment Indicators. Using PCR & VIX Practically - I канала Bharat Jhunjhunwala