You have probably seen people say things like "this market sentiment is very pessimistic" or "it is very optimistic right now," but you may wonder how they can actually tell.
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Judging sentiment from price alone is like driving while looking only at the rearview mirror. A more reliable read comes from combining four core indicators in the options market. These four indicators map to volatility expectations, directional expectations, extreme risk, and actual buying and selling pressure. Together, they help you build a more complete picture of market sentiment.
Step 1: Start with volatility expectations: Implied Volatility
What it does: Measures how the market is pricing overall future uncertainty.
How to use it: Find the implied volatility of at-the-money options in the option chain and see where it stands relative to its own history. You can think of it as the average price of insurance across the whole market. It reflects how worried the market is about the future overall.
How to read it: When IV keeps rising, the market is pricing in greater uncertainty, so sentiment is more nervous. When IV keeps falling, the market is becoming more complacent and risk appetite is higher.
Step 2: Then look at directional expectations: Risk Reversal
What it does: Measures whether the market is more worried about falling or more excited about rising.
How to use it: Compare the implied volatility difference between out-of-the-money put options and out-of-the-money call options with the same degree of moneyness. The formula is: OTM put IV minus OTM call IV. This spread tells you whether the market is spending more money to protect against a drop or more money to bet on a rally. Academic research also confirms that option-implied skewness is closely related to market sentiment.
How to read it: A positive spread means puts are more expensive than calls, so the market is paying a higher premium for downside protection and sentiment is more defensive. A negative spread means the market is rushing into call options, so sentiment is more optimistic.
Step 3: Look at extreme risk expectations: Implied Skew or Jump Risk
What it does: Measures how much the market is pricing in tail events.
How to use it: Watch whether the implied volatility of out-of-the-money puts, especially deep out-of-the-money puts, is clearly higher than that of out-of-the-money calls. When the left tail is visibly elevated, the market is guarding against extreme downside risk. Recent academic research has also proposed more refined tools, such as extracting an implied jump expectation index from options data to quantify how worried the market is about sudden shocks.
How to read it: A clearly elevated left tail means the market is protecting against a crash. An elevated right tail means the market is protecting against a sharp rally. If both rise at the same time, the market is entering a state of two-sided fear.
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Step 4: Look at actual buying and selling pressure: Put/Call Volume Ratio and Net Buying Pressure
What it does: Shows what money is actually buying, rather than what people are saying.
How to use it: Pay attention to the Put/Call volume ratio, which is the ratio of put option trading volume to call option trading volume. Academic research shows that net buying pressure in options, meaning the flow of money actively buying option contracts, contains useful information about future market direction and volatility.
How to read it: A sharp rise in the volume ratio may mean the market is adding more downside protection, but that is not necessarily a bearish signal. It could also mean investors are selling puts to collect premium because they believe the market will not fall. So this indicator needs to be used together with the previous ones. Reading it alone can easily lead to misjudgment.
How to verify your read: Next time you want to judge market sentiment, put these four indicators into one table and watch them together. If IV is high, Risk Reversal is positive, and the Put/Call volume ratio is rising, then all three signals point in the same direction. That suggests the market is in a systematic defensive state, and directional bets require more caution.
