Put-Call Ratio

What is a Put-Call Ratio (PCR) ?A ratio of the trading volume of Put options to Call options is called Put-Call Ratio. It is used to gauge investor sentiment.
PCR, alias put-call ratio, simply put, is the ratio of trading volume of put options to call options. Changes in this ratio are indicative of the prevailing market sentiment. For instance, a higher PCR, which arises when put volumes are relatively higher than that of calls, signals a bearish sentiment.
As traders usually use put options to fix a sell price for their securities when they anticipate a fall in price, a rise in put volumes is usually an indicator of the bearish mood in the market. Put options are contracts that give the holder the right to sell a specific quantity of the stock at a specified price on or before the expiry of that contract.
On the contrary, increase in volumes of call options, by the virtue of its definition, can largely be assumed as an indicator of a build up in bullish sentiment. This is so because holders of call options have the right to buy a specific quantity of the stock at a specified price on or before the expiry of that contract.
While typically the trading volume is used to compute the Put-Call Ratio, it is sometimes calculated using open interest volume or total dollar value instead. Weekly or monthly figures can also be calculated and moving averages are often used to smooth out the short term daily figures.

How to Read it??
However, history suggests that options traders lose money most of the times. Their collective judgement of market direction is usually wrong. It is precisely for this reason that a high put call ratio usually precedes a rising market and a low ratio is followed by falling prices.
For instance, in January 2008, the volume-based put-call ratio for nifty options had fallen from over 1.5 in early January to under 0.7 by mid-week. However, the markets turned in the deep correction mode only by mid-January — a time when greed ruled high in the markets as captured by the relatively low PCR. To give another example, in July 2007, the PCR had risen to over 2; broad markets, on the contrary rose by over 4 per cent that month.

Markets in the short-term are driven more by emotions than fundamentals. Times of greed and fear in the market are reflected by the significantly low or high PCR. This makes PCR an effective contrarian speculation tool that assesses the general herd mentality in the markets. While, typically, PCR above one indicates a higher put volume vis-À-vis call volumes, for Indian stock markets we can peg the optimal level at 1.2 to 1.5. This is because in our markets puts are used more for hedging than speculation and, hence, PCR only above or below this level may be construed as an effective indicator of an overbought or oversold market.

However, PCR as an indicator has its own flaws. PCR levels in a highly volatile market can be misleading as, typically, during such times, traders tend to sell puts instead of buying calls. So, while on an overall basis, put call ratio can be used as a market indicator, it could prove costly you if time markets solely based on put-call ratio.

Issues of Corporate Governance - Institution of Independent Directors

The institution of independent directors has been one of the most global innovations in recent times. So much so that without independent directors corporate governance seems a lost cause. However, the institution of independent directors is under an existential threat from within and without.
The Securities & Exchange Board of India (SEBI) has mandated that all listed companies should have a certain number of independent drectors. The definition of an independent director brought in through the listing agreement with the stock exchanges is quite comprehensive. Unfortunately, the definition in the Companies Bill, 2008, cuts at the root of independence, which should be reviewed and corrected.
In practice, independent directors have largely remained independent only on paper. The recent Satyam fraud has created a fear psychosis in the minds of independent directors. This has been exacerbated by the Andhra Pradesh government's move to arrest former independent directors of Nagarjuna Finance for alleged default in repayment of public deposits.
The judicial response in the Nagarjuna Finance case has been anything but reassuring to independent directors.
Many independent directors have left and those who are continuing are not quite happy continuing. Unless the situation is remedied, there is a real danger of losing this nascent institution.
PROTECTION
The moot question here is whether independent directors should have a statutory protection against arrests except in most extraordinary circumstances by the Central Regulatory Agency. In a country like India where foisting of criminal cases is quite common in certain segments of society, such a trend would be suicidal if allowed to affect independent directors. Hence, it is desirable that independent directors are given a statutory protection as stated above.
In the prevailing era where the Indian economy is slowly but surely integrating with the global economy, the need for a global reach and size cannot be ignored by the first hundred companies in India. It is true that a few of these today are owned predominantly by families. It is not an exaggeration to say that such companies would have to grow at an exponential rate to acquire a global size and raech.
To realise this the capital requirements would be beyond the reach of the controlling families. Such companies would have to access necessarily domestic and global capital markets for their capital needds. This can be done well only if the governance standards are quite high with competent independent directors providing the much needed re-assurance of the same.
CORPORATE FRAUDS
Corporate frauds and scams greatly erode corporate wealth. Corporate India as a whole should have a vested interest in preventing and minimising corporate frauds and scams.
Independent directors on audit committees provide one of the best ways of reinforcing internal audit and annual statutory audit. Thus, independent directrs, who are truly independent, can be an effective bulwark against corporate frauds and scams. If corporate India is serious about raising the bar on governance standards, it should appoint competent independent directors after a thorough search.
APPOINTMENT
If a modicum of independence on teh part of independent directors is to be ensured, a total revamping of the process is called for. Only the nomination committee of the board consisting solely of independent directors should have the responsibility to propose the names of independent directors.
The principal promoter of the company should disclose to the nomination committee the nature of any relationship that he has with the person (s) proposed to be appointed as independent directors of the company.
The nomination committee could release an advertisement in national newspapers giving stringent eligibility criteria for appointment of independent directors and calling for applications.
To avoid frivolous and unnecessary applications, a good system of pre-registration and screening could be introduced by the regulator so that only a person who is registered with the regulator would be eligible to respond to the advertisement.
After a small number of the candidates is short listed, the nomination committee should have a transparent system of selection of the candidate and the process of such selection should be put on the company's website.
The actual appointment of an independent director should be only by postal ballot. All financial institutions, banks, mutual funds and foreign institutional invevstors, who are shareholders, should be encouraged by the Regulator to participate in such a postal ballot.
The nomination committee should give detailed reasons for nomination of a particular candidate in the explanatory statement to the resolution proposing the appointment.
The details of the votes cast for and against the proposal should be put on the website of the company.
Such an appointment based on the support of the broad spectrum of shareholders would give confidence to the candidate to be slightly independent of the overpowering influence of the principal promoter of teh company.
RETIREMENT
For ensuring better independence, both real and perceived, it would be appropriate that an independent director should not continue as such for more than two terms of three years each.
It is normally argued that such a move would not ensure proper experience in a particular industry, as the independent director has to move away after six years.
This argument would not always hold good if one were to look at independent directors as enlightened generalists who bring to bear upon everything that they do and think a certain freshness of approach without the bias of traditional experience and conventional thinking.
Furthermore, for industry experience, there are the executive directors on the board, to provide the necessary guidance to the independent directors on industry matters.
Hence, it would not be inappropriate to provide a ban on the continuance of the independent director on the same board beyond two terms
It is also important that an independent director should not be on more than five boards so as to allow sufficient time and focus to be an effective independent director on the existing boards. It is also desirable that the remuneration of the independent directors is reasonably attractive.
TRAINING
Continuing education for independent directors would be highly advisable. Premier management and professional institutes are already running development programmes for independent directors. However, attendance at such programmes is yet to catch up.
The corporate governance report should give details of management development programmes attended by the independent directors of the company.
It would not be a bad idea to set up a self-regulatory body called 'The Institute of Independent Directors'. It could be a top of the lilne institution to nurture, promote and regulate the profession of independent driectors.
Nurturing the profession of independent directors requires a great amount of restraint and imagination on the part of the regulators and the law enforcers so that eminent and honest people are not discouraged from being independent directors.
The future growth of India depends to a large extent on sustainable wealth creation by the corporate sector. Business leadership founded on a good corporate governance model can ensure such sustainable wealth creation to a large measure.
For this, independent directors are absolutely necessary.
Therefore, the task of nurturing the institution of independent directors as a national priority cannot be over-emphasised.

The HUBRIS Hypothesis

[hubris (hyoo-bris) noun. Overbearing pride or presumption, excessive pride or self-confidence]

The Hubris Hypothesis of Corporate Takeovers

The Hubris Hypothesis is advanced as an explanation of corporate takeovers. It suggests that there is a tendency for acquisitor companies to pay too much. Company managers are over optimistic about their ability to add value to a new company.
Hubris on the part of individual decision makers in bidding firms can explain why bids are made even when a valuation above the current market price is essentially a valuation error. Bidding firms are said to be infected by hubris simply tend to pay too much for their targets.
It is often argued by varoius experts that there really are no gains associated with corporate takeovers and even if there are, they are highly overestimated and the source of these small gains are basically 'elusive'.
The basic steps undertaken in a corporate takeover are -
a) The bidding firm identifies a potential target firm
b) A "valuation" of the equity of the target firm is undertaken. It may typically include any nonpublic information. Also, the valuation would incorporate any estimated economies due the synergy effect or the negatives like a weak management (that will cause a discount in the target's market price).
c) This 'value' is compared to the current market price of the target firm. If the value is below the price, the bid is abandoned. However, if the value is above the market price, a bid is made. (The bid typically would not be the previously determined 'value', since it should include provisions for rival bids, for future bargaining with the target and valuation errors)
So, the key element here is the "Valuation" of the target firm. The valuation of an asset that has an observable market price (a preexisting active market) must be distinguished from other bids for assets that trade infrequently. In takeover attempts, the current market price forms a lower bound, as the bidder knows for certain that the shareholder will not sell below that.

Now let us consider a case of no potential synergies or any other source of takeover gains but the bidding firms believe that such gains exist. This means that valuation can be considered a random variable whose mean is the target firm's current market price. Only when the random variable exceeds the mean, a bid offer is made. But when there aren't any sources of gains for the bidding firm, the takeover premium is a mistake made by the bidder.
But if there were no value at all in takeovers, why would firms make a bid in the first place? But such behaviour rests on the assumption that individual are rational beings. A typical individual bidder believes that the valuation is right and is convinced that the market does not reflect the full economic value of the combined firm. This is the underlying premise of the Hubris Hypothesis - When there are no actual aggregate gains in a takeover, the takeover can be explained by the overbearing presumption of bidders that their valuations are correct.

The hubris hypothesis is consistent with strong form market efficiency. Financial markets are assumed to be efficient in the sense that a) no industrial reorganization can bring gains in an aggregate output at the same cost or reductions in aggregate costs with the same output and b) management talent is employed in its best alternative use.
Although perfect form market efficiency is unlikely, it does serve as an ideal benchmark against which other forms of efficiency are measured.