Many people think that options can only be used for speculating or hedging; however they can also be used for predicting the future movements in the stock market. PCR also known as put call ratio can be a great tool for predicting the stock market if it used correctly. The put-call ratio is often used by the option traders or investors to measure the sentiment of the market. Put call ratio can be calculated by dividing the number of traded put options by the number of traded call options. As put call ratio increases, it can be interpreted to mean that investors or traders are buying put options rather than call options. An increase in buying of put options signals that market participants are of the view that the market will move lower, or they are hedging their portfolios in case if market goes down.
A higher put call ratio indicates that market as a whole is bearish whereas a low put call ratio signals that market view is bullish about the future. Therefore a contrarian trader will buy when the put call ratio is high in the hope that whole market is bearish and if market goes up by any reason then it will lead to short position getting covered by short sellers whereas when put call ratio is low a contrarian trader will buy the market in the hope that as there is too much pessimism in the stock market it can lead to rise in the market.
As one can see that put call ratio can be good tool for predicting the future movements of stock market, however it should be used with caution, as in stock market nobody can predict the market accurately every time.