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Saturday, April 1, 2023

Track volume PCR, trade of short-term sentiments: Shubham Agarwal

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Data analytics in futures and options has always been fruitful in getting insights on what the participants are expecting from the underlying. One such indicator that gives insights on short term sentiments is Volume Put Call Ratio.

VOL – PCR = Total Volume of PUT/ Total Volume of CALL

One must remember, unlike OI (open interest), which increases when more contracts are open and decreases when the contracts are settled, volume increases with every transaction. Now, the logic is fairly simple. Keeping many other factors along with OI aside, volume in itself does indicate strong activity in the instrument.

Based on the same logic, Volume PCR compares Put volume with Call volume. The ratio will be higher if Put Volume is more and lower if Call volume is more. No prize for guessing that if activity a.k.a. volume in Calls is more then expectation of upward momentum can be established. On the other hand, if volume is more on Put side then expectation of downward momentum can be established.

One more thing that has been observed over past years is that just like Open Interest Put Call Ratio even Volume PCR is also mean reverting in nature. In simple words on an overall basis it moves in the range.

In a nutshell:

Volume PCR is generally negatively correlated with the Underlying. It is Rising when Underlying is Falling and Falling when Underlying is Rising.

Rising VPCR = More PUTS are being traded than CALL – Trader’s view is bearish as PUT traders are Hedging more

Falling VPCR = More CALLS are being traded than PUT – Trader’s view is bullish as CALL traders are making bullish bets.

Finally, day’s volume is concluded at the end of the day, hence this remains end of day indicator.

Now comes the question how to Trade it.

As we discussed earlier Volume PCR is mean reverting in nature. The range may not be so standard but frequent sequence of similar ups and downs can be seen.

A simple indication can be drawn out of this rangebound movement. If we plot chart of Volume PCR it would look something like this.

Setting expectation for trading this short-term sentiment is as simple as its indications. All we need to do is observe the bottom being made and the rise in Volume PCR could actually give us a heads up of Put activity picking up pace showing bearish short-term sentiments. Similarly, on its way down from an immediate top short-term bullish sentiments can be gauged.

Volume PCR still remains a short-term sentimental indicator, but it comes in very handy. Recent spike in Volume PCR with Nifty around 18000 Mid-February 2023 was a very good example why one should also keep looking at this sentimental indicator closely.

Finally, making this data is easy and since it has to be done only once a day one can easily get the same done from NSE’s end of day Bhavcopy. Alternatively, there are option analytic applications too that carry this indicator.

Disclaimer: The views and investment tips expressed by experts on Moneycontrol are their own and not those of the website or its management. Moneycontrol advises users to check with certified experts before taking any investment decisions.

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