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Indian Stocks • Beginner
Team CoinSwitch
•
27 July 2023
Even those with a background in finance sometimes find options trading bewildering. Investors think they can make money rapidly with options, but sometimes, one wrong move can leave you broke. So it is essential to understand terms like CE and PE in stock market options trading.
Let’s begin with the basics of options trading, though. We’ll get to CE and PE soon enough.
What are CE and PE in the Stock Market?
The abbreviation CE refers to call options, but it literally stands for Call European. So, what is CE? CEs in the stock market is a type of investment contract. They give the holder a choice, but not the duty, to buy a stock, product, bond, or another asset at a specific price within a predetermined window of time.
The buyer of stock benefits if the asset’s price increases. But purchasing a call option on security offers the investor the option of purchasing a set number of shares at a specified price (called the strike price) before a particular day (that is, the expiry date).
And what is PE? PE is the abbreviation of Put European, and it essentially stands for Put Option. PE in trading is another type of contract. It grants the option holder the right, but not the obligation, to sell some security at a set price (the strike price) inside a predetermined window of time. A put option is the exact opposite of a call option.
A purchaser and a seller are required for every transaction. Similarly, investors cannot buy call options unless there are corresponding put options.
Understanding the CE and PE ratio
The put/call ratio is a popular indicator that investors use to gauge the state of the market. A high ratio suggests that traders are pessimistic and they are buying more puts than calls. The converse is true for a low ratio. So if they buy more calls over puts, one may expect a bull market.
Importance of the CE and PE ratio in stock analysis
The CE and PE ratio helps traders guess the future trajectory of an asset of interest. This type of forecasting tool is essential for the performance of traders. It helps them remove bias from any analysis and gives them an easy way to arrive at options trading decisions.
That said, it is never a good idea to base a trading decision on the basis of one metric alone. In conjunction with other metrics, the put/call ratio can be of great use.
How to calculate CE and PE ratio
Two formulas are available to calculate the Put/Call Ratio (hereafter PCR). The first option is as follows:
PCR = Put Quantity / Call Quantity
Here, the Put Quantity and Call Quantity represent the total amount of put and call options traded on a given day.
Another way to calculate PCR is as follows:
PCR = Net Put Open Interest / Net Call Open Interest
As an illustration, the PCR for an asset is 1,250/1,785, or 0.7, if, on a particular day, there were 1,250 puts and 1,785 calls traded for the asset.
Interpreting the CE and PE ratio in the stock market
The denominator of the put/call ratio includes the total number of call options. The ratio’s value will thus rise if fewer calls are exchanged. This is noteworthy because fewer calls can raise the ratio without increasing the number of puts. In other words, the ratio might increase even without a significant rise in put purchases.
PCR can help determine how the market feels about recent news or earnings. If the ratio reaches extreme levels, it signifies either an excessively bullish or bearish state.
Equity traders purchase higher puts than calls if the put/call ratio rises over 0.7 or exceeds 1. Investors in such cases may be protecting their portfolios against a sell-off or betting that the exchange market will fall lower.
A ratio under 0.7 and close to 0.5 is a positive sign. It indicates that more calls than puts are being purchased.
When there is the same number of calls and put purchasers, the ratio equals 1. A ratio of 1 is not going to help you determine the market direction. However, there are frequently more people buying calls than puts or vice versa.
CE and PE ratio as indicators of stock valuation
A very high put/call ratio usually indicates that the stock market is quite damaging. However, a contrarian view might see this as a bullish indicator. They may argue that since the market has been too negative, it is poised for a reversal. A contrarian may therefore view a high ratio as a good time to purchase.
Similarly, a meager ratio indicates that market bullishness is at an all-time high. But a contrarian may conclude that the stock market is overbought and is overdue for a downturn.
Anyone ratio cannot, therefore, singlehandedly accurately predict a peak or bottom. Even the ranges of the ratio change over time and are not fixed.
Investors usually compare current ratio readings to the long-term averages to determine a change in sentiment. When PCR abruptly increases after fluctuating in a narrow range, for instance, traders may interpret this as a sudden rise in negative sentiment and act accordingly.
From all of this, it must be clear that before entering the world of options, a healthy dose of caution and DYOR is indispensable.
FAQs
What is the Fullform of CE in stock market?
In the context of the stock market, “CE” typically stands for “Call Option European Style.”
What is call and put option?
A call option is a financial contract that gives the buyer the right, but not the obligation, to buy an underlying asset at a predetermined price (strike price) within a specific time period. A put option, on the other hand, gives the buyer the right, but not the obligation, to sell an underlying asset at a predetermined price (strike price) within a specific time period.
What is the difference between buying CE and selling PE?
Buying a CE (Call Option European Style) means acquiring the right to buy the underlying asset at a specified price within a specific time frame. Selling a PE (Put Option European Style) refers to the act of granting someone else the right to sell the underlying asset at a specified price within a specific time frame. In summary, buying a CE gives you the option to purchase, while selling a PE grants someone else the option to sell.
What is strike price in option?
The strike price, also known as the exercise price or the striking price, is the predetermined price at which the underlying asset can be bought or sold when exercising an options contract. It is the price at which the buyer of the option has the right to buy (in the case of a call option) or sell (in the case of a put option) the underlying asset.
What is a good PE ratio?
A good PE (Price-to-Earnings) ratio can vary depending on the industry and market conditions. Generally, a lower PE ratio may suggest that a stock is relatively undervalued, while a higher PE ratio may indicate that it is overvalued. However, it is essential to consider other factors like growth prospects, industry comparisons, and company-specific circ*mstances when evaluating the attractiveness of a stock based on its PE ratio.
What is F&O PE and CE?
F&O stands for Futures and Options. PE refers to Put Option European Style, which gives the holder the right to sell the underlying asset. CE refers to Call Option European Style, which gives the holder the right to buy the underlying asset. These are common terms used in the derivatives market for trading options contracts.
Disclaimer: Risk is fundamental to the investment process in Indian stocks. Any discussion of securities in this article should not be considered a recommendation to buy or sell any security. The facts provided are for informational purposes only and should not be considered investment/financial advice from CoinSwitch.
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