Stocks & Commodities V. 22:4 (52-55): Dollar-Weighted Put/Call Ratios by Fari Hamzei and Barbara Star Ph.D.

OPTIONS

Incorporating Price And Volume

Dollar-Weighted
Put/Call Ratios
Does this new twist on the popular
sentiment indicator hold some
predictive value? Find out here.

by Fari Hamzei
and Barbara Star, Ph.D.

any years have

passed since Mar-

M tin Zweig used

end-of-day option
trading activity to
create the put/call
ratio. Since then, it has been widely
followed as a measure of market
sentiment. It reflects the emotional
aspect of trading by identifying the
degree to which traders feel optimis-
tic or pessimistic about near-term
market direction. Because it reveals
what traders are thinking, many be-
lieve that the put/call ratio holds
some predictive value.
The original put/call ratio is based
on total option contract volume for
the day. It aggregates all put and call
option volumes into one ratio. But
options traders know that prices fluc-
tuate throughout the day, and thus,
not all contracts for a given stock or
index are created equal. Wouldnt it
make more sense to track changes in
option trading on a real-time basis
GEORGE THOMPSON

and incorporate both price and vol-

ume in the calculation? That was the
premise Fari Hamzei wanted to test.
He managed to create the code and
gather the information needed to pro-
duce real-time, dollar-weighted put/call ratios, thanks to call ratios made it possible to isolate potential explosive
improved computer technology and Internet speed. short-term price moves.
For the past three years, HamzeiAnalytics.com has been
taking the emotional temperature of traders on an intraday STANDARD VS. DOLLAR-WEIGHTED PUT/CALL
basis. The company monitors 225 actively traded stocks, plus The original put/call ratio compares the trading volume of put
market indexes and actively traded sector exchange-traded options to the trading volume of call options over the same
funds (ETFs), using real-time, dollar-weighted put/call ratios. period for an underlying asset such as the Standard & Poors
Hamzei found that tracking the intraday dollar-weighted put/ 100 index (OEX). The standard put/call ratio is simply the
Copyright (c) Technical Analysis Inc.
Stocks & Commodities V. 22:4 (52-55): Dollar-Weighted Put/Call Ratios by Fari Hamzei and Barbara Star Ph.D.

total number of put option contracts traded

in a given day divided by the total number
of call option contracts traded that same
day. It does not account for the variation
in option premiums for different strike
prices and different expiration dates. In-
stead, it values every contract as if it were
the same. For example, if the total volume
of all the option contracts traded for a
given day was 300 puts and 600 calls, the
standard put/call ratio would be 0.5.
In contrast, the dollar-weighted put/call
ratio incorporates both option volume and
option price. It measures the amount of
money flowing into put options relative to
calls. Calculating the dollar-weighted put/
call ratio is more complicated than calcu-
lating the standard put/call ratio. For each
trade, the formula is:

Sum Option premium * No. of put contracts

Sum Option premium * No. of call contracts

The result is then accumulated every

minute throughout the trading day. This FIGURE 1: EBAY SPREADSHEET. This Excel spreadsheet of eBay shows a partial example of the process
makes it possible to take snapshots of the required to obtain real-time, dollar-weighted put/call ratios. This process is repeated simultaneously with
way that money surges into or out of an more than 250 stocks and indexes every minute of the trading day.
entity during the trading day.

DATA GATHERING
To demonstrate the enormous amount of
data and number-crunching involved, here is
Figure 1, a partial example on only one stock,
using a five-minute data collection period.
Showing the timeline of 8:30 am, 8:35 am,
and 8:40 am Central Time, the spreadsheet
displays the dollar-weighted puts, calls, and
accumulated ratio for each contract in the
option chain (that is, all contract months and
strike prices available to the public on that
day) during those periods.
The accumulator in row 5 sums each
time period and adds the previous amounts
to the current time period. The resulting
dollar-weighted put/call ratio is displayed
in row 6. In general, the numbers become
TRADESTATION

more meaningful as the trading day

progresses.
The value of using the dollar-weighted,
real-time put/call ratio, in contrast to the FIGURE 2: INTRADAY S&P 100 ON APRIL 4, 2000. As shown on this 15-minute price chart, within a few
standard put/call ratio, lies in its clarity hours of the opening on April 4, 2000, the OEX index dropped 60 points before recouping most of its loss.
and responsiveness to immediate swings
in the sentiment pendulum. It enables trad-
ers to view changes in investor sentiment
as they occur.

Copyright (c) Technical Analysis Inc.

 Stocks & Commodities V. 22:4 (52-55): Dollar-Weighted Put/Call Ratios by Fari Hamzei and Barbara Star Ph.D.

Nowhere was this more evident than on April 4, 2000,

when all the major indexes experienced their highest
intraday point drops ever before recovering most of 14.00
their losses by the end of the day. The Dow Jones
Industrial Average (DJIA) fell 700 points, the Standard 12.00
Dollar-weighted
& Poors 500 fell 110 points, the OEX fell 60 points, and put/call ratio
10.00
the Nasdaq Composite dropped 634 points. Figure 2 is
a 15-minute intraday price chart of the OEX on that day,
8.00
and Figure 3 shows a comparison chart of that same day
with both the intraday dollar-weighted and the standard
6.00
end-of-day put/call ratios on that very same day.
As the comparison chart clearly demonstrates, the
4.00
standard put/call ratio gave almost no signal, whereas
the dollar-weighted put/call ratio revealed much more
2.00
fully the true impact of the move by rising as price fell.
The standard put/call data was simply too flat to Standard put/call ratio
0.00
provide a reliable signal. The dollar-weighted put/call

m
m

am

am

pm

m
pm
5a
5a

5a

5a

5a

5a

5p
.45
.15

.45

.15
8.4
ratio, on the other hand, was much more specific

8.1

9.1

9.4

1.1
11.

11.

12
10

10

12
because it also calculated the total dollar amount on
each side of the ratio. FIGURE 3: PUT/CALL RATIO COMPARISONS ON APRIL 4, 2000. This chart
compares the real-time, dollar-weighted put/call ratio (in pink) with the standard put/call
LOOK FOR EXTREMES ratio (in blue) on the same day as Figure 2 (in Pacific time). The high in the dollar-
When the dollar-weighted put/call ratio tips signifi- weighted put/call ratio corresponded to the intraday low on the OEX, SPX, and Nasdaq
Composite indexes. The increased sensitivity to price volatility of the dollar-weighted
cantly more to one side than the other, the chances put/call ratio created an extreme reading not evident on the standard put/call ratio.
increase for a sharp price move within a few hours or a
few days. This is especially likely when an extreme
reading is accompanied by high liquidity, as measured
by recent dollar-weighted volume.
What constitutes an extreme reading? For the
S&P 500, readings of 05 are bearish, while
those above 10 are bullish (as illustrated in EBAY (eBay Inc.) Put/Call Ratios
Figure 3). For the Nasdaq 100, readings of 010
are bearish and those above 20 are bullish. 1.2 $61.00

The opposite interpretation applies to stocks

1.0 $59.00
and ETFs. For stocks and sector HOLDRS, read-
ings of 0.10.5 are bullish and readings of 2.0
0.8 $57.00
and up are bearish. The closer to zero, the more
Ratio Value

Closing price
bullish; the farther away from 2, the more bear- 0.6 $55.00
ish. Readings of 0.62.0 are neutral and produce
no signals. Extreme readings occur more often 0.4 $53.00
on stocks than on the indexes.
Comparisons with historical end-of-day, dol- 0.2 $51.00
lar-weighted put/call ratios highlight the ex-
0.0 $49.00
tremes. For instance, on October 27, 2003, with
10/06/03
10/07/03

EBAY trading at $55.81, the dollar-weighted put/

10/08/03
10/09/03
10/10/03
10/11/03
10/12/03
10/13/03
10/14/03
10/15/03
10/16/03
10/17/03
10/18/03

call ratio was 0.1 intraday on good volume. That

10/19/03
10/20/03
10/21/03
10/22/03
10/23/03
10/24/03
10/25/03
10/26/03
10/27/03

meant 10 times as many dollars were being

10/28/03
10/29/03

Date

Dollar-weighted put/call Closing price

The options markets are excellent
forward-looking discounting
mechanisms, often providing an
early indication of a turn in
market sentiment.
FIGURE 4: EBAY DOLLAR-WEIGHTED PUT/CALL RATIO. This three-dimensional represen-
tation is the historical end-of-day overview of eBay price (green bars) and its dollar-weighted
put/call ratio (blue bars) during October 2003. The scale on the left is the put/call ratio level,
and the scale on the right is the closing price. The dollar-weighted put/call ratio generated a
bullish signal on October 27.

Copyright (c) Technical Analysis Inc.

Stocks & Commodities V. 22:4 (52-55): Dollar-Weighted Put/Call Ratios by Fari Hamzei and Barbara Star Ph.D.

invested in EBAY calls versus puts. As the his-

torical chart in Figure 4 illustrates, the end-of-
day numbers remained a strong 0.16. The next
day, the stock was up almost two points and
proceeded to trade higher on an intraday basis
over the next few days (see Figure 5).
An example of a bearish trade occurred on
September 23, 2003, with Federal Home Loan
Mortgage Corp. (FRE), better known as Freddie
Mac. The stock was trading at the $54.50 level
and generated a dollar-weighted put/call ratio of FIGURE 5: EBAY INTRADAY PRICE CHART. This is a 30-minute price chart of
5.4 intraday on good volume. As seen in the October 2729, 2003. The arrows point to the original bullish signal and the
historical end-of-day chart (Figure 6), the dollar- subsequent move up over the following two days.
weighted put/call ratio went on to close at a still-
bearish reading of 3.57 by the end of the day. FRE (Federal Home Loan Mortgage Corp.
That meant three times as much money was (Freddie Mac)) Put/Call Ratios
being invested in puts compared to calls. Two
days later, the stock price fell more than two 4.5 $56.00
points when it hit an intraday price low of $52.08 4.0
Bearish signal $55.00
(see Figure 7). 3.5
$54.00
3.0
CONCLUSION

Closing price
$53.00
Ratio value

In todays challenging market environment, trad- 2.5

$52.00
ers are constantly striving to improve their re- 2.0
sults by sharpening their trading edge. For those 1.5 $51.00
traders, the options markets are excellent for- 1.0
$50.00
ward-looking discounting mechanisms, often $49.00
0.5
providing an early indication of a turn in market
0.0 $48.00
sentiment. Empirical observations have shown
09/02/03

that with both end-of-day and real-time data, the

09/03/03
09/04/03
09/05/03
09/06/03
09/07/03
09/08/03
09/09/03
09/10/03
09/11/03
09/12/03
09/13/03
09/14/03

dollar-weighted put/call ratio can alert traders to

09/15/03
09/16/03
09/17/03
09/18/03
09/19/03
09/20/03
09/21/03
09/22/03
09/23/03
09/24/03
profitable opportunities.

09/25/03
09/26/03
Date
Fari Hamzei is the founder of
HamzeiAnalytics.com, former vice president of Dollar-weighted put/call Closing price
Market Analysts of Southern California, and the
FIGURE 6: FEDERAL HOME LOAN (FRE) DOLLAR-WEIGHTED PUT/CALL RATIO. The arrow on
current leader of the Los Angeles TradeStation the three-dimensional historical chart points to a bearish signal given on September 23, 2003, when
Users Group. He served on the board of directors the dollar-weighted put/call ratio reached an extreme.
of Electronic Clearing House (ECHO), a Nasdaq-
listed company, for 11 years.
Barbara Star, Ph.D., is a former university
professor and part-time trader and a frequent
contributor to S&C. She is a past vice president of
the Market Analysts of Southern California and
led a MetaStock users group for many years.
Currently, she provides individual instruction and
consultation to those interested in learning tech-
nical analysis.

SUGGESTED READING
Zweig, Martin [1994]. Winning On Wall Street,
Warner Books.
See Traders Glossary for definition
FIGURE 7: FEDERAL HOME LOAN (FRE) INTRADAY PRICE CHART. The 30-
minute intraday chart of FRE tracks the price decline that followed within a few days
of the bearish put/call signal.

Copyright (c) Technical Analysis Inc.