The put/call ratio calculates the trading volume of put contracts outstanding for a particu- lar stock or stock index divided by trading volume for the total number of outstanding call options. The ratio is sometimes viewed as an investor sentiment indicator: When the ratio is relatively high, investors are bearish about market conditions; when the ratio is rela- tively low, investors are bullish.
a. Under the "Indices" tab, download monthly data over the most recent five years for the level of the Eurex Index Option Put Call Ratio (EUXDIPC).
b. Calculate the average value for this ratio for: (1) the full five-year period; and (2) each of the past five one-year periods. Explain what you think the trend this ratio has exhibited over time implies about investor expectations for the European stock market.
c. Download monthly price data over the most recent five years for the Dow Jones Euro Stoxx 50 Index (DJEURST), Europe's leading indicator of blue-chip companies. Use these price data to calculate monthly returns (i.e., price changes without dividends) for the five-year period. (Note: You will lose one month from the sample period when you convert prices to returns.)
d. Calculate the correlation coefficient between two series: the EUXDIPC ratio and the DJEURST for the same month (i.e., both from month t for a given pair of observations).
e. Repeat your calculation of the correlation coefficient with the following adjustment: use the EUXDIPC ratio lagged by one month (month t-1) paired with the DJEURST from month t (i.e., you observe the put/call ratio one month before you observe the DJ Euro stock index return). You will lose another observation when you lag the put/call ratio data series.
f. Interpret the correlation coefficients that you have calculated in Parts d and e and explain whether either of them supports the view of the put/call ratio as an effective indi- cator of market sentiment.