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g stock。for a relatively small initial investment。 The price of a call option is。most dependent on the price of the underlying stock。relative to the strike price； the stock's。volatility； and the amount of time remaining until the option expires。 But in all cases； the call option price will be a fraction of the stock。price； and in many cases； this fraction will be very small indeed。
To illustrate； lets。assume Stock A； which does。not pay a dividend； is。currently trading for 50 and an investor is。expecting the stock。to move to 60 during the next three months。 If the annualized volatility of the stock is。25 percent—typical of many of the blue chips—a three…month call option with a strike price of 50 will trade for about 5 percent of the share price； or 2。50 in this。case。 If the stock。should in fact reach 60 by the time this。call option expires。in three months； the 50…strike call option will have a value of 10 in the listed options。market。
So； in this。case； the call option will have quadrupled from 2。50 to 10 on a move by。the underlying from 50 to 60； and thus。a gain of 300 percent could have been realized by the option buyer on just a 20 percent gain in the stock。 And the leverage in this。case would have been 15 to 1 （300 percent/20 percent）。 Put another way； the option holder achieved a profit of 7。50 with an investment of just 2。50； whereas。the 10 gain realized by the stock。holder required a 50 investment。
Needless。to say； the scenario described above was。on the best…case end of the spectrum for the call option buyer。 Note； for example； that if the stock。does。not rise above 50 during the life of the option and the position is。held until expiration； the call buyer will lose 100 percent of his。investment。 And in the case of the on…the…money option—when the stock。price is。equal to the strike price—such total losses。can be expected to occur 50 percent of the time。
Based on this。quick。risk…reward profile； one can reasonably conclude that call option buyers。（those who are said to have long call…option positions） are rather aggressively bullish in the pursuit of leveraged profits—bullish enough to be risking a total loss。of their investment if they're wrong。
The buyer of an equity put option； however； has。the right but not the obligation to sell a stock。at a specified price （the strike price） for a specific。period （at the end of which the option expires）。 The put option buyer is。as。aggressively bearish as。the call option buyer is。aggressively bullish。
So in its。purest form； the options。world consists。of two constituencies： the aggressively。bullish call option buyer and the aggressively。bearish put option buyer。 In addition； the listed options。market provides。a treasure trove of information about the activity of call and put buyers。in each of the thousands。of underlying stocks。on which options。are traded。 Trading volume data are available for calls。and for puts； as。well as。option open interest； which represents。the number of option contracts。open at any time。
Gauging。Investor Sentiment
It should be no surprise； therefore； that technical and quantitative analysts。have made ongoing efforts。over the years。to measure the relative intensity of put and call activity as a gauge of the sentiment of aggressive investors。 Stocks。on which these investors。are very。bullish—as。indicated by greater call activity than put activity—could be deemed byntrarians to be vulnerable。 An excess。of bullish options。sentiment could be an indication of investor exuberance and overmitment； and the resulting dearth of sideline buying power could pave the way for a major pullback。 Similarly； stocks。on which investors。are very。bearish—as。indicated by greater put activity than call activity—could have significant upside potential。 An excess。of bearish options。sentiment could indicate investor pessimism and capitulation； and the resulting buildup of sideline buying power could pave the way。for a major rally。
Surprisingly； the focus on put and call option activity over the years。has。been pretty well restricted to：
1。
Aggregate options。data across。all equities。rather than an equity…by…equity。analysis。 A seriesmonly quoted by analysts。is。the “CBOE Equity Put/Call ratio” which represents。the trading volume of all puts and calls listed on the Chicago Board Options Exchange。 This。aggregation of equity options data may have made sense decades。ago； when few individual equities。had robust markets。in their options。 But these days。there are many equities。with options。that trade thousands。of contracts。each day and with option open interest equivalent to millions。of shares。of stock。
2。
Option volume； as opposed to open interest。 Option open interest is。a much more stable series。than option volume。 Option volume can vary very significantly from day to day； whereas。open interest adjusts。incrementally each day based on the number of positions that were opened or closed the day before。 In addition； option volume can be subject to all manner of intraday 〃noise〃； including the activities。of day traders who hold no position at the end of the day。
Schaeffer's Open。Interest Ratio
Schaeffer's。Investment Research has。attacked the deficiencies。of traditional put/call ratio analysis。on each of these two fronts。by developing a ratio of put open interest to call open interest for even optionable stock。 This。ratio is。referred to as。the SOIR （Schaeffer's Open Interest Ratio）； and it is。updated daily in the data presented on SchaeffersResearch； as。well as。for the pany's。internal analysis。 A graph of the SOIR can tell a very。interesting story of the option trader sentiment toward a particular equity； and this。unique perspective can add considerable value to an analysis。of a stock's。technical picture。 Before delving into some pelling examples。of SOIR analysis； consider the potential pitfalls。of this。approach。
Again； in its。purest form the options。world consists。of two constituencies： the aggressively bullish call option buyer and the aggressively bearish put option buyer。 For purposes。of maximizing the value to contrarians。of put/call ratio analysis； there would be another element to this。〃purity；〃 namely； the participants。in the options。market would be confined to relatively unsophisticated individual investors。 In such a pure options。world； we would know that heavy call activity （or heavy put activity） would be the result of a strongly。
bullish （or strongly bearish） view held by the unsophisticated crowd； and； as。such； traders should consider taking the contrarian approach of fading this。activity。 But the real world of options。differs。significantly from this。pure world that would delight the contrarian。
1。
Options。market participants。include professionals。stub as。large money managers and； particularly in recent years； hedge funds。that trade very。actively。 Many of these larger investors。are quite sophisticated and have access。to valuable information well beyond the scope of the smaller individual investor。 To automatically take a position counter to the option activity of thisntingent would be foolish indeed。
2。
Option activity。is。by。no means。always。initiated by buyers。 For example； there is。quite a large constituency that sells。call options。against stock。they own as。a tool for generating additional ine； and others。who seek。a similar objective by selling puts。against cash。 And some traders。sell uncovered （or 〃naked〃） calls； which is。a bearish bet that a stock。will not rise above the call strike price。 If heavy call activity is。the result of a surge in covered or naked call writing； it certainly would not indicate a wildly bullish investment view。
3。
Option activity can occur in conjunction with trades。（or positions） in the underlying stock。 One example would be when a covered call position is。initiated。 Another would be the purchase of put options。to protect a long stock。position from a major decline； perhaps。ahead of a critical earnings。report。 Option activity that results。from strategies。that involve the underlying stock。（or strategies。that involve the buying and selling of other options。on that stock） can dilute the value of put call ratio analysis。
4。
Hedge funds。in particular use options as part of 〃pairs。trading〃 strategies。 For example； a put option on an energy exchange…traded fund （ETF） might be purchased in conjunction with a long position in Occidental Petroleum （OXY） if the manager feels。that the stock。will outperform its。sector。 So the purchase of the puts。in this。case is。not a reflection of a bearish view on energy but rather a hedge for a bullish view on a particular energy stock。
Considering。the Extremes
So the perception of a put call ratio as。a clear indication of the bullish （or bearish） sentiment of a crowd of unsophisticated traders。is。certainly a flawed one。 But
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bullish contrarian plays。that is。turbo…charged from two standpoints：
1。 A trader will bolster the effectiveness of hisntrarian conclusion。 The major conundrum of sentiment analysis。results。from situations。in which the sentiment simplynfirms。the price action in the stock。 So a stock。that doubles。in price during a one…year period is。very likely to be the object of a fair amount of bullish