Mint Explainer: Why all eyes are on this market indicator ahead of poll results

As per the current put-call ratio, the market is anticipating a victory for the ruling Bharatiya Janata Party-led (BJP) National Democratic Alliance. (Image: Pixabay)
As per the current put-call ratio, the market is anticipating a victory for the ruling Bharatiya Janata Party-led (BJP) National Democratic Alliance. (Image: Pixabay)


  • The put-call ratio, a key measure of market sentiment, suggests a bullish outlook on the results of the general election

As India braces for the 2024 Lok Sabha election results, due on 4 June, investors are turning to the put-call ratio (PCR) in index options contracts for insights. This key indicator, which measures market sentiment by comparing the number of outstanding put contracts with call contracts, reveals whether the mood is bullish or bearish. Currently, the PCR suggests a bullish outlook on the poll outcome.

Options are instruments used by investors and traders to hedge their portfolios or speculate on major events, such as the election results on 4 June. Investors and traders will closely monitor the PCR of the 6 June expiry of Nifty contracts, as it aligns with the date of the election results.

Mint gives a lowdown on this important indicator.

What are options contracts?

Like futures contracts, options derive their value from cash shares and spot indices like the Nifty and Bank Nifty. The equity market has two segments: the capital market segment, where shares are bought and sold, and the derivatives segment, where stock and index futures and options contracts are traded or hedged. 

Read This | Mint Explainer: Why the national election is making the market swing wildly

Options contracts are of two types: calls and puts.

Call option contracts enable the purchase of an underlying share or index at a pre-set price for future delivery, while puts facilitate the sale at a pre-set price for future delivery. Since indices can't be delivered, they are cash-settled.

Calls are purchased on expectations of a rally, and puts on expectations of a pullback or correction.

There are two critical aspects to consider: call and put sellers assume unlimited risk for earning a relatively low premium (the price paid by the buyer), and unlike futures contracts, options lose value over time. The longer you hold the contract, the more time decay erodes its price.

Sellers, often more experienced than buyers, assume unlimited risk. They are typically proprietary traders or high net worth investors using sophisticated algorithms. 

Option buyers, largely retail investors, face a maximum loss of the premium paid. It is said that sellers win eight out of ten times, while buyers succeed only two times out of ten.

What does the outstanding put-call ratio tell you?

PCR is the total number of put options divided by the total number of call options in an option chain, indicating whether there are more puts relative to calls or vice versa, thus reflecting the market's mood.

More Here: In final stretch of polls, markets raise a vote of confidence

Looking at the Nifty option chain for the 6 June weekly expiry (each monthly derivatives series usually has four weekly expiries), we find that at 11am IST on Tuesday, there were 390,890 call contracts and 439,111 put contracts outstanding.

Dividing 439,111 by 390,890 gives a PCR of 1.12, meaning, for every 100 call contracts, there are 112 put contracts. This suggests that more Nifty puts have been bought than calls ahead of the 4 June, likely as a hedge against potential market corrections.

Alternatively, considering the seller's perspective, the PCR indicates bullish sentiment if it's high, as sellers believe the Nifty won't fall below the strike price sold minus the premium received. Hence, they've written more puts than calls, expecting to pocket the premiums paid by buyers by 6 June or before.

Conversely, if calls outstanding were 439,111 and puts 390,890, the PCR would be 0.89, signalling bearish sentiment since more calls sold than puts suggest sellers think the Nifty won't rise above the level (strike) sold plus premium received.

The normal PCR is 1. A reading of 1.5 and above signifies an overbought market, while a reading of 0.7 indicates an oversold market.

The takeaway

With a PCR of 1.12 for the 6 June expiry, the market anticipates a victory for the ruling Bharatiya Janata Party-led (BJP) National Democratic Alliance, which would ensure policy and economic continuity.

This sentiment, however, may change after the exit poll results on 1 June, the final day of the ongoing Lok Sabha election. If the BJP wins fewer seats than expected or is defeated, the equity markets could plunge as put sellers will scurry to cover their short positions, exacerbating the downward trend.

Also This: Investors take cover ahead of election outcome

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