If you are a trader, you have probably heard of the term ‘Option Chain’. For an option trader, one needs to have a clear understanding of how to read an option chain. Most beginners find the data intimidating, but once you understand the basics, the option chain becomes the most powerful tool for analysing market sentiment.
In this blog, we will understand what an option chain is, the key components of an option chain and how to read an option chain.
What is an option chain?
An option chain is a detailed table that displays all available call options (CE) and put options (PE) for a particular stock or index. It provides important information like strike prices, premiums, volume, open interest, and implied volatility.
For index traders, the Nifty 50 option chain gives a complete picture of the current market trend.
It is essential to understand the key components of an option chain before you start your analysis of an option chain.
- Strike Price
This is the price at which you buy or sell the underlying asset. There are three types of strike prices:
- ATM (At-The-Money) – These are the closest strike prices to the market price.
- ITM (In-The-Money) – These strike prices can be profitable if exercised now.
- OTM (Out-of-The-Money) – These strike prices are farthest from the market price, and they are yet to be profitable. OTMs are very risky to trade, but traders use them while hedging to reduce the premium.
- Call (CE) and Put (PE) options
- Call options reflect bullish expectations.
- Put options reflect bearish expectations.
An option chain displays both CE & PE side by side for easy comparison.
- Last Traded Price (LTP)
It displays the most recent traded price of an option. Traders use it to understand the premium trend.
- Bid/ask price & quantity
Bid price is the price buyers are willing to pay, and requested quantities are displayed in the ‘Bid Qty’ column. Similarly, the ask price is the price sellers are willing to accept. If the bid-ask spread is very close, it means high liquidity.
- Open Interest (OI)
OI indicates the number of outstanding contracts. Rising OI represents more traders entering the position. The decline in the OI represents positions being closed. OI is used for confirming market direction.
- Change in OI
It is a key sentiment indicator for intraday traders. It helps to identify long build-up, short build-up, short covering, and long unwinding.
- Implied Volatility (IV)
IV shows the expected future volatility. High IV represents expensive options, and low IV represents cheaper options. Events like budget announcements often cause IV spikes.
- Volume
Volume represents participation in that specific strike. Beginners should avoid strikes with very low volume.
How to use an option chain?
Here is a step-by-step approach for analysing the option chain:
- Identify the ATM strike price.
- Compare OI on the CE and PE sides to find where traders are building positions.
- Check IV for abnormal spikes – it will help you to avoid overpriced premiums.
- Study LTP movement along with change in OI for trend confirmation.
Once you open a demat account and access the trading platform, you will be able to view current option chains in real time and start applying this process.
Common mistakes beginners make
- Focusing only on premium (LTP) and ignoring OI or IV
- Trading the strikes which have low liquidity
- Misinterpreting OI data during event volatility
- Not tracking bid-ask spreads
- Taking trades without connecting the option chain data to price action
Avoiding these mistakes can significantly improve the success rate of any trade you take.
Conclusion
Mastering the option chain analysis is essential for a trader who wants to succeed in the options market. Understanding the basics of option chain analysis will remarkably improve decision-making for any trade. The more you analyse, the faster you learn.
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