OCA (Options Chain Analysis) is the ultimate tool to differentiate knowledgeable intraday traders from everyone else. In a fast-paced environment like intraday trading, having an advantage is being able to read the market's emotional feeling, as well as preempt (prior to their testing) key new support and resistance levels, so you can trade with more authority. In essence, the options chain provides lots of insight into how the "smart" investors are positioning themselves.
This guide will help you learn how to read and interpret the data provided by the Options Chain Analysis to use it to find overall support and resistance levels for the securities in which you are currently trading, to improve your intraday trading results.
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Key Components of Option Chain
The options chain is a chart showing the various strike prices/expiration dates associated with the options of a specific security (i.e., stock/index). To understand how to utilize the Options Chain to your advantage, you need to familiarize yourself with the primary metrics involved in evaluating the Options Chain.
1. Open Interest (OI)
Open interest is the total number of short or open contracts held by traders. Open interest measures the degree of investor interest and liquidity in the market.
Intraday insight = A high open interest for a strike price means that there are many option writers (sellers) who believe that the market will not go above that strike price (i.e., there is little/no support at that level). This forms a very strong attraction/force field. Observing the daily changes in open interest is necessary in order to provide timely signals to execute trades.
2. Volume
Definition: Volume refers to the aggregate number of contracts traded on a given day.
Intraday Insight: If there is a lot of volume on a strike price and it matches with a favourable change in open interest, it gives credibility that this level of volume is authentic and provides more confidence in the implied support level and resistance level.
3. Implied Volatility (IV)
Definition: The market's anticipated volatility of the underlying security's price will be what the IV represents.
Intraday Insight: Changes in IV will affect the baseline cost to purchase an option. If the IV increases, then the baseline cost to buy an option rises (causing the option itself to become more expensive); likewise, the reverse is true. A significant increase in the IV may indicate that a large price event is forthcoming or a small price event (decrease) is forthcoming. Therefore, the level of IV should be carefully considered when determining your best strategy for intraday trading.
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Intraday Trading Strategies with Option Chain Analysis
The true value of a thorough analysis of an option chain is in mapping out the battlefield for intraday trading.
A. Identify Support and Resistance (OI Fortress)
One of the most practical uses of an option chain analysis is to identify key support and resistance areas more accurately than by looking at standard chart patterns.
Intraday Action:
Keep a Watch on the Growth of Open Interest: Open Interest on Call Options indicates a Strong Resistance Level.
Strong Call Option Structure Will Drive a Short Covering Rally if Underlying Prices Break Above Strong Call Open Interest Levels.
B. Gauging Market Sentiment with the Put-Call Ratio (PCR)
Put-Call Ratio(PCR) is a speculative indicator calculated by option chains.
PCR = Total Put Open Interest / Total Call Open Interest
Intraday Action: Combine PCR with Price Movement: If the Stock is falling and PCR is starting to Rise Towards an Extreme (oversold), a Potential Buy Entry is Present.
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Role of Option Greeks in Intraday Analysis
The Option Greeks Explain the "How": Option Greeks Are Used to Determine How Much Option Premium Will Change Over Time & Stock Volatility Through Rapid Changes in the Underlying's Price.
1. Theta: The Time Decay Factor
Theta is the Rate an Option's Premium Loses Value over Time (Time Decay).
Theta is the number one enemy of every intraday trader who buys options, as Theta is at its highest for options that are At-The-Money (ATM). The rate of acceleration of Theta is greatest as the time to expiration approaches. To reduce the effects of Theta, intraday traders should concentrate on buying an option that still has a reasonable amount of time premium attached (i.e., not just going to expire today or tomorrow); or alternatively, look at different strategies where the trader actually sells options to take advantage of Theta decay.
2. Delta
Delta indicates how much an option's price changes with every one-point change in the underlying asset's price.
Intraday Insight: Delta helps you choose the right strike price.
Typically, ATM options will have a Delta close to 0.50; therefore, ATM options will typically move about 50% of what the underlying would move. ATM also offers the greatest amount of leverage and time decay balance.
In-The-Money (ITM) options will usually have a Delta much higher than the ATM options or (closer to) a Delta of 1.00; therefore, they require more capital outlay.
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Risk Management and Best Practices for OCA
Option Chain Analysis is a good tool, but it is not a guarantee of success. Trading successfully within the intraday model requires consistent discipline and risk management, and there is no one source or indicator that is sufficient to guarantee success.
1. Combine OCA with Technical Analysis:
Always pair OCA signals with the best and most commonly used tools for technical analysis: volume profile analysis, moving averages, candlestick patterns, and others. As an example, you should only enter a long trade when you see a significant level of support from a large open interest in put operations and a confirmation of a bullish reversal pattern, such as a shooting star candlestick pattern (the name is misleading and implies bearish, but the principle is the same for any reversal candlestick).
2. Prioritize Liquidity:
Liquidity is an important factor when choosing the best contracts. By choosing Contracts with High Open Interest (OI) & Volume, you will find lower Bid/Ask spreads, which will help you execute trades better & have less slippage (important for day trading).
3. Define Your Exit:
The same OCA Signals will also be used to exit. After you have bought a Call Option at a Strong Put OI Support Level, you should Take Profits as the Price reaches a Strong Call OI Resistance Level.
4. Understand the Derivatives Market:
Understanding the Derivatives Market is critical to developing a deep understanding of your Trading Environment (How To Trade In The Derivatives Market).
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Conclusion
Using Option Chain Analysis will provide you with a roadmap to successfully navigate the Complex Options Market Data and Assist You in Successfully Day Trading using Open Interest (OI) to determine Support & Resistance; the Put Call Ratio (PCR) to assess Market Sentiment; and combining both Theta & Delta to provide you with a powerful Objective Advantage. Implement Option Chain Analysis as Part of Your Daily Routine, and you will Achieve A Greater Level of Success in The Derivatives Market.
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