S22 Part V: Index Options and Futures 
Interpreting the Ratio. There are several philosophies as to how to inter­
pret the ratio once it has been calculated. All philosophies are of the contrarian 
variety, so the general comments made earlier that high ratios are bullish and 
low ratios are bearish still hold true. However, quantifying just what is "high" 
and what is "low" leaves room for interpretation. 
One school believes that absolute ratios should be used. An example might be: 
"if the 10-day moving average of the equity put-call ratio is over 0.60, that is a buy 
signal." Unfortunately, applying absolute figures to any of the ratios can be counter­
productive at times. If the market is in the grip of a prolonged bearish move, more 
and more puts will continue to be purchased, sending the ratio quite high before it 
can reverse and start coming back to normal levels. Therefore, it is better to look for 
the ratios to make a high or a low before calling a buy or sell signal. This is a more 
dynamic interpretation; it allows for buy and sell signals to come at different absolute 
levels of the put-call ratio. 
Figure 29-1 shows the 50-day equity put-call ratio going back several years (the 
daily figures for the previous 50 trading days are averaged to produce the number 
plotted on the chart each day). One can see that at certain times, the put-call ratio 
reached extreme heights before finally generating a buy signal. Attempting to call a 
buy on the market at an absolute level would have been an error because the entry 
point would have come too early. Notice that the readings in late 1990- as the mar­
ket bottomed in advance of Operation Desert Storm - were actually higher on an 
absolute basis than those made after the stock market crash in 1987. Similar obser­
vations can be made for sell signals after the ratio has reached low levels: don't antic­
ipate - wait for the ratio to bottom out and tum up before declaring a sell signal or 
to roll over and turn down before declaring a buy signal. 
The index put-call ratio is shown in Figure 29-2. It tells a similar story to the 
equity ratio, although there are certainly differences - beyond the obvious one that 
the ratios have different absolute values. Note that this ratio averages about 1.00 
while the equity ratio averaged about 0.50. 
At times, index put buying becomes extensive even as the market climbs. This 
does not generally happen with equity options. It seems that institutional money 
managers, who are long stocks, are afraid that they will lose their profits after a quick 
stock market advance. However, rather than sell their stocks, they buy puts (possibly 
overpaying for them). Thus, they are really bullish (they own stocks), but they are 
buying puts as a hedge. 
This is a difficult situation for the contrarian. What is the institutional manag­
er's true bias? Is he bullish because he still owns stocks or is he bearish because he 
is buying puts? This is the bane of contrary analysis - attempting to accurately inter­
pret the data that is being received. Figure 29-2 shows that the index put-call ratio