The stock market is where fortunes are made and lost. Those who succeed often say it requires a good understanding of various terms, tools, and approaches. One tool that can enhance your knowledge of the stock market is the option chain. Sounds complex? Well, it is not complex once you familiarise yourself with it.
In this blog, you will learn about options, option chains and understand their types along with benefits. You will also learn about how to analyse and use it effectively as part of your trading strategy.
Options are a type of derivative instrument. Derivative means that they derive their value from an underlying asset, for example, a stock, commodity, etc.
Options come in the form of financial contracts that give you the right, but not the obligation, to buy or sell an asset. The contract has a predetermined price and can be executed before a specific date.
There are two main types of options:
1. call options which give you the right to buy an asset at a specific price.
2. put options which give you the right to sell an asset at a specific price.
To check the available options contracts, you need to refer to Option Chains. Let’s understand what are option chains.
An option chain is a comprehensive list that shows you all available option contracts for a given stock. These are sorted by their expiration date, which is the last day you can trade or use the option, and strike price, which is the price at which you can buy (call) or sell (put) the stock.
For example, if you are interested in trading options for ABC Ltd, the option chain will list all available option contracts for ABC Ltd, sorted by expiration date and strike price. You can compare the premiums (which is the cost of buying the option) and other data to decide which option you would like to trade in.
Also Read - How to do Nifty Intraday Option Trading?
Here’s a breakdown of the main elements you need to know to analyse and read options chains.
The strike price is the predetermined price at which you can buy or sell the underlying asset when exercising the option. You’ll find strike prices listed in the option chain. These represent different levels at which options can be exercised (bought or sold).
The bid price is the highest amount a buyer is ready to pay for an option. The ask price is the lowest amount a seller is ready to accept. These prices indicate the market's current interest and the range within which trades are likely to occur. In an option chain, the bid and ask prices help you gauge the liquidity and potential profitability of different options contracts.
When looking at the option chain, you will also come across Volume. It refers to the number of option contracts traded during a specific period. A high volume indicates significant trading interest, suggesting that the option is actively bought and sold.
When you begin options trading, you may come across OI. So, what is OI in the option chain? OI or open interest refers to the total number of outstanding option contracts that have not been settled. Simply put, it tells you how many options contracts are active/open in the market. It provides insight into the option's liquidity. Higher open interest means more traders are interested in that option, making it easier to enter and exit positions.
Let’s see how you can use these elements to understand the option chain better. Suppose you're analysing the option chain for XYZ Ltd, with its stock price at ₹2,500. You'll see various strike prices. For call options, strike prices might be ₹2,600, ₹2,700, etc., and for put options, they might be ₹2,400, ₹2,300, etc. The bid and ask prices for each strike price show the market's willingness to buy and sell at those levels. If there's high volume and open interest at a particular strike price, it indicates strong interest and potentially more liquidity, making it easier to trade those options.
The option chain offers several benefits. Let’s take a look at some of the ways in which it can enhance your trading journey:
|
Benefit |
Description |
|
Ease in identifying trading opportunities |
With an option chain, you can spot potential trading opportunities by viewing a range of available options. This makes it easier to find options that match your market outlook and investment goals. |
|
Comparison of options |
The option chain allows you to compare prices and other factors across different options. This helps you find the best option that fits your trading strategy and budget. |
|
Risk management |
You can use the option chain to evaluate and manage risk by comparing different options with varying strike prices and expiration dates. This helps you choose options that align with your risk tolerance. |
|
Strategy development |
The comprehensive data in an option chain assists you in developing and refining your trading strategies. You can analyse different scenarios and choose the best approach based on current market conditions. |
|
Market sentiment analysis |
The option chain offers insights into market sentiment or how other traders are feeling about the market. By looking at the volume and open interest data, you can see which options are popular. High volume and open interest in certain options can show you where other traders are focusing their attention, indicating possible price movements. |
When using option chains, you can take two main approaches to enhance your trading strategy.
1. The index approach
2. The stock-specific approach
The index approach involves analysing indices to understand overall market trends. Indices like Nifty or Sensex represent the performance of a group of stocks, giving you a snapshot of the market sentiment. By studying their option chains, you can see trends and predict whether the market is likely to go up or down.
The stock-specific approach focuses on individual stock options. By examining these, you get detailed insights into a stock’s potential performance. Look at the open interest and volume data to determine if a stock is gaining or losing interest among traders. This helps you decide whether to buy or sell.
Options trading can be a lot smoother with the use of option chains. While it may take some getting used to, it can help you adopt a more calculated approach while trading. If you want to learn more about derivatives trading and strategies, Sharekhan Education can offer the right guidance. With the resources offered, you can master some of the commonly used tools and enhance your trading skills.
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