Have you heard of OIPCR? It may well answer question of ‘Kay Lagta Hai?’ for markets

Shubham Agarwal

In an attempt to answer the infamous ‘Kay Lagta Hai?’ we will try and explore derivatives facts. I will share today my learning of one such indicator that would be able to answer this question about the mood of the market.

Participants as a set more often than not would give away consensus over expectations via aggregate positions, especially in the F&O market.

One such consensus can be drawn out of a sentimental indicator called Open Interest Put Call Ratio (OIPCR).

Total Open Interest of All the Calls*

* of a particular underlying

But, before we get into that, let us have a refresher on the intention that initiates the action of buying or selling options.

4. Sell (Write) Put when Neutral to Bullish

Back to OIPCR again, like every other indicator OIPCR also works on a simple premise of intention behind the action.

Now, one school of thought says Option is like insurance and the providers of Insurance a.k.a. Option Writers know more about the underlying asset (in insurance example our life expectancy).

It is because Option Writer pays margin for a trade which would always have an unfavorable reward to risk profile, so more writers bring in stronger intention.

The idea I am trying to drive here is that if we have more Call writers than Put writers that means the majority of writers (the wise ones) hold the expectation of Neutral to Bearish Underlying. While more put writers indicate otherwise.

Now, put the Open Interest values into OIPCR and we would have a figure. If the OIPCR is more than one it means that more Put Writers (Put Open Interest means Put Writer & Buyer both) than Call Writers.

This indicates by the virtue of being outnumbered consensus tilting towards Neutral to a bullish bias. Had it been below ‘1’ than other way around, Participants’ consensus tilting towards Neutral to Bearish Bias.

So, OIPCR more than 1 Bullish, less than 1 Bearish.

However, major utility that we have found out of this indicator is much more than this. The more part is that OIPCR is also used to gauge the extremes in the market consensus (not extremes in underlying but extremes in consensus).

To put things in perspective imagine when OIPCR goes far beyond more than one, the mood turns from Bullish to Extremely Bullish.

Similarly, if OIPCR is more close to 0 than 1 the situation indicates an extremely bearish mood. The takeaway here is extreme is not sustainable hence would generally be a major turning point in the underlying (major top/ bottom).

Although the question of how much is too much is very tricky, it could be answered by looking at empirical evidence. Especially for indicator like OIPCR which generally would not show values beyond 0-2. However, I would say take an objective approach.

Least we can do is plot basic Statistics on it.

Gather past readings, find the Average (of 20 readings = ~ 1 expiry), Find Standard Deviation (STDEV in MS Excel) of same readings. Add 2 X STDEV to the Average to get the upper band & Reduce 2X STDEV from the Average to get the lower band.

These are your indicative extremes of OIPCR a reading close to Upper / Lower band would indicate the market Mood is ether extremely Bullish/ Extremely Bearish and chances are that there is a Comma (Consolidation) in the offing if not a Full Stop (Reversal).

Thus OIPCR not only lets you know the mood of the market but also would alert in case we are close to the extreme.