Author: Robert C. Koch
Summary
- On average, option traders lose about 80% of the time (Nithin Kamath, CEO Zerodha, July 4th, 2021). Thus, the put to call ratio is often used as contrarian indicator when reaching extreme levels.
- In this article, we will analyze the effectiveness of the put-call ratio as contrarian indicator to exploit extreme levels of greed and fear within the option market.
- To reduce the subjectivity of interpretation in the term “extreme greed and fear levels of the put-call ratio”, we apply descriptive statistics to derive precise thresholds to identify appropriate entry- and exit points.
- Afterwards, we analyze these entry- and exit points based on their average forward-looking returns on the S&P 500 and test them for statistical significance.
- Finally, we introduce a new way on how to improve the trading results by applying the z-score statistics to the put-call ratios.
- The put-call ratio as well as its z-score normalization, show statistical significances in identifying attractive entry- and exit points.
