Since mid-March, stock indices have rallied on the back of FED-intervention to be (once again) positive for the year. While there are cold-hard facts that indicate the economy is NOT where it was on January 1st, 2020 - the market is singing its own tune. Granted, the market is NOT the economy and can diverge for quite sometime.
All that being said - the put-call ratio is a measurement used to determine extremes in the market. It is a measure of how many puts (bearish positions) are being initiated vs. calls (bullish positions). When this ratio's 10-day average falls below .70 - the market is more susceptible to an above-average downside move.
Looking at the chart above we can see about 6 signals over the past year. When the blue moving average rises above the green dotted line - market participants are too bearish and a market rally is likely forming. Opposite that - when the blue moving average falls below the red dotted line - market participants are too bullish and a market top is forming. The markets can remain bullish or bearish for extended periods of time, as seen in the upmove from October 2019 to February 2020 and the downmove from March 2020 to April 2020. However, it generally keeps you out of trouble.
At present, we are in a precarious position. The put-call is indicating a top is near while businesses worldwide are finally re-opening and giving investors confidence. The pullback that appears imminent could be small and short-lived or it could be deeper and more severe. There is no way to know. However, this indicator should keep the smart investors out of trouble and signal when it might be safe to get back in the water.