Nifty option chain analysis for retail investors

Nifty option chain analysis for retail investors


Nifty option chain analysis for retail investors




An option chain is a list of all the available contracts which includes both put options and call options. An option chain is available for all the future and options stock and major index of the stock market e.g. Nifty or Bank nifty. There are several terms used in option chain analysis like strike price-open interest-implied volatility-change open interest-premium-call-put. Let's discuss these terms in details

Open interest in Option chain analysis

  1. Open interest represents no contracts.
  2. Contracts create when  buyers and seller agree to trade with each other 
  3. E.g. If 1 seller sell 1 contracts and 1 buyer purchase 1 contract it will create open interest of 1
  4. Higher the no of contracts on call side it will act as a resistance for stock or index
  5. Higher the no of contracts on put side it will act as a support for the stock or index
  6. But why the highest open interest will act as a support or resistance for stock or index?
  7. Because Option selling required high margin. If stock crosses and trade above the highest open interest level option seller will lose a high amount of money.
  8. Option sellers are the market makers and option buyers are retail investors
  9. 99% of options expire at zero and most of the retail investors lose money in option buying.
  10. But why retail investors always buy options?
  11. Because option selling requires large capital. E.g. If you buy 1 nifty contract at 70 and a lot size is 75 the total money you required to buy the contract is 70*75=5250 but if we try to sell the option it required a margin of 96,000. 
  12. Therefore retail investors buy the option and institutional investors sell options contracts. 

Implied volatility in the Option chain analysis

  1. Implied volatility is used to drive the option price of a particular strike
  2. Higher the implied volatility higher the option prices
  3. Lower the implied volatility lower the option prices
  4. If implied volatility reduces option price will reduce
  5. If implied volatility increase option price will increase
  6. Therefore for option buyers, it is advised to buy the option contracts when implied volatility is low and for option sellers, it is advised to sell the option when implied volatility is very high.

Change open interest in the Option chain analysis

  1. When contracts added on the next trading day or contracts are closed it reflects as a change in open interest. 
  2. So why the change in open interest is important?
  3. As discussed earlier Highest open interest will act as support and resistance for stock and index but if the open interest on the highest open interest level on-call side decreases the stock or index will break the resistance level and move up. If open interest on the highest open interest level on-put side decreases the stock or index will break the support level and move down.

Premium in the Option chain analysis

  1. What is the premium?
  2. Premium is the value of the contract for a particular time period of a particular strike price
  3. There are two types of premium call and put premium.
  4. Call side premium increases when the market moves up
  5. Put side premium increases when the market moves down
  6. Call side premium decrease when the market moves down
  7. Put side premium decreased when the market moves up.
  8. Therefore before buying the option contracts ensure the direction of stock or index moving or find the trend of the stock or index.

Standart terms used in the Option chain analysis

  1. Long Build up 
  2. Short Build up
  3. Short Cover
  4. Long Unwinding

Standard rules for Long build up in option chain analysis 

  1. Analyze call side premium & open interest and put side premium & open interest 
  2. On-call side when premium increases and change in open interest increases
  3. On-put side when premium decreases and change in open interest increase 
  4. It is a sign of long build-up in stock or index and stock or index will move up if both cases applied

Standard rules for Short Build up in option chain analysis 

  1. Analyze call side premium & open interest and put side premium & open interest 
  2. On-call side when premium decreases and change in open interest increase 
  3. On-put side when premium increases and change in open interest increases
  4. It is a sign of short build-up in stock or index and stock or index will move down if both cases applied. Logic is already explained in open interest columns.

Standard rules for short cover in option chain analysis 

  1. Analyze call side premium & open interest and put side premium & open interest 
  2. On-call side when premium increases and change in open interest decreases
  3. On-put side when premium increases and change in open interest increases
  4. Before this stock or index should close in negative zone previous day
  5. Previous day call sellers will cover their positions when the market moves up
  6. Short covering in stock or index happens when there is positive news about stock or market
  7. It is a sign of short covering in stock or index and stock or index will move down if both cases applied. Logic is already explained in open interest columns.

Standard rules for long unwinding in option chain analysis

  1. Analyze call side premium & open interest and put side premium & open interest 
  2. On-call side when premium decrease and change in open interest increase
  3. On-put side when premium increases and change in open interest decreases
  4. Before this stock or index should close in positive zone previous day
  5. Previous day put sellers will cover their positions when the market moves down
  6. Short covering in stock or index happens when there is positive news about stock or market
  7. It is a sign of short covering in stock or index and stock or index will move down if both cases applied. Logic is already explained in open interest columns.

Max pain theory in the option chain

  • Max pain theory is used for call buyers - Generally, in the stock market, the smart money used to sell the options  and retail investors buys the options 
  • Option selling required high margin and options buying required small margins  
  • 95% of open interest in options expires at zero and 95% retail investors lose money in that options and smart money earn money from the premium
  • To cover the large no of retail investors money max pain theory is created
  • In max pain theory the sum of call side open interest and put side open interest at particular strike price premium should be zero or near to the value when the option expires
  • This theory covers maximum retail investors and large no of retail investors lose money in option on the expiry day.    

Use max main theory to find the direction of the market using the option chain

  • As we already discussed the maximum open interest act as a support and resistance in the stock market
  • First, we need to calculate the total open interest in the call side and put the side of the various strike prices.
  • After calculating find the highest open interest strike price 
  • After finding the highest open interest strike price find the difference between the nifty closing price and strike price.
  • If nifty closing - highest open interest strike price value is greater than the premium of nifty closing stock price market will return to the highest open interest level
  • E.g. nifty closing at 12226 - 12000 is the highest open interest the difference here is 226 and the premium of nifty 12200 call side is 75+ put side premium 50 = 125. Therefore the difference is greater than the premium nifty will move down but how much?
  • To find the value of the movement 
  • Find the value find the sum of second-highest open interests and their premium.
  • The movement will be 25-30 % less the premium of the second-highest open interest 
  • E.g. Second highest open interest is at 12200 and the premium of 12200 both call and put side is 125. The downside movement will be 100 from the 12200 level 
  • In this way, maximum call buyers will lose money on the expiry day.

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4 Comments

  1. in example E.g. nifty closing at 12226 - 12000 is the highest open interest the difference here is 226 and the premium of nifty 12200 is 75+50 = 125
    What is 75 and 50?

    ReplyDelete
    Replies
    1. This is the premium of 12200 strike price call side and put side. Total addition is 125

      Delete

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