What is Option Chain – How to Use it

Option chain, a fundamental tool in options trading, unveils a comprehensive list of available option contracts for a specific underlying asset. By presenting vital details like strike prices, expiration dates, and open interest, the option chain aids traders in assessing market sentiment and making informed decisions based on options data. Let us discuss what the option chain is and more about it in detail.

What is Option Chain

You might be familiar with the two types of financial contracts, options and futures. An options chain is used to access all the listed options contracts. An options contract allows the investor to purchase or sell an underlying asset at a predetermined price (strike price) on a future date (exercise or expiration date). It is crucial to note that an options contract does not obligate the investor to sell or purchase the underlying asset on the exercise date. The investor can choose to ignore the contract on the exercise date.

An option chain displays all the listed contracts with both puts (sell options) and calls (buy options). It is also known as an options matrix and helps in options trading the following day. All the available options contracts for an underlying asset are displayed in the options chain. It will contain essential details, like strike prices, exercise dates, and option types. These details allow option trades to make informed decisions while trading.

Usage of Option Chain

Option chain charts are essential for derivatives traders. They help investors with a detailed list of all options contracts for underlying assets, like stocks or indexes. Options chain also helps understand the market sentiment, implied volatility, and other factors. Here’s how you can use an options chain:

Understanding Market Sentiment

An option chain shows the distribution of call and put options. Investors can use the strike prices to summarise the current market sentiment. For instance, an increased number of call options indicates bullish sentiment of investors. On the other hand, investors’ sentiment is bearish when there are more options.

Identifying Support and Resistance

Support and resistance levels can be determined through options chains. Investors can analyse the open interest (open contracts) at a particular strike price to determine support and resistance levels. A high open interest on a particular strike price can help understand the investors’ approach.

Evaluating Implied Volatility

An option chain can help you understand the implied volatility for a particular asset. You can understand the investors’ speculation for future prices of a particular asset. When the implied volatility is high, there is increased uncertainty in the market.

Make an Informed Trading Strategy

Traders can use the data in an option chain to develop effective trading strategies . They can develop strategies that help achieve investment goals based on open interest at different strike prices. You can also develop your trading strategy based on the investors’ sentiment. For instance, your trading strategy might differ for bearish and bullish markets.

Risk Management and Hedging

An options chain helps understand the risks associated with different positions in the market. Investors can understand the market sentiment and identify potential risks. For instance, investors learn about increased uncertainty in the market through an options chain. Investors can also use an options chain to hedge themselves from declining prices. For example, many investors purchase put options to hedge themselves from plummeting prices.

Options Chain Analysis

Option chain analysis can help make informed decisions. You can access the option chain table and make decisions accordingly. Before we discuss each component of the table, let us discuss the five major points:

Type of Option

An option chain will contain two main columns- call and put options . These are the two types of options contracts used by investors. There will be more columns under both call and put options. A call option allows you to buy an underlying asset at a strike price on a future date. On the other hand, a put option allows you to sell an underlying asset at a strike price on a future date. However, none of the options force you to buy or sell assets on a future date.

Strike Price

Options contracts allow you to buy or sell securities on a future date at a predetermined price. The predetermined price is called the strike price. The strike price will be mentioned in the middle of the concerned chain table. You will find entries for call and put options on either side of the strike price.

Recommended Read: What is Derivatives Trading

ITM (In the Money)

It is a situation where the current market price (spot price) is more than the strike price mentioned in a call option. Similarly, an ITM situation can arise when the spot price is less than the strike price mentioned in a put option. Call/put options traders will likely profit when the situation is ITM.

ATM (At the Money)

It is a situation where the strike price mentioned in an options contract is equal to the current market price, also known as the spot price.

OTM (Over the Money)

It is a situation where the strike price mentioned in a call option exceeds the current market price. Similarly, OTM can occur when the strike price mentioned in a put option is less than the current market price. OTM is a situation that defines a loss for call/put options traders.

Here are the main components in an option chain table:

Component in the Option Chain Meaning

OI (Open Interest)

It denotes the total number of outstanding contracts for a particular strike price and exercise date.

Change in OI

It denotes the change in open interest.

IV

It stands for implied volatility.

Volume

It helps understand the number of options contracts traded on a particular strike price and exercise date within a given time.

LTP

It stands for the Last Traded Price. It represents the last price at which an options contract was traded.

Net Change

It helps understand the net change in LTP.

Bid Qty

It helps understand the demand of buyers for a particular options contract.

Bid Price

It represents the price of the last buy order.

Ask Price

It represents the quoted price of the previous sell order.

Ask Qty

It helps understand the demand of sellers for a particular options contract.

Significance of NSE Option Chain

The NSE option chain can be discovered on the official website of the National Stock Exchange. You can find option chains for different securities traded on the National Stock Exchange . You can also find option chains for popular indices like Nifty. Here’s how option chains offered by NSE help investors:

  • They help investors discover ITM and OTM options. Based on ITM and OTM options, investors can get an idea of profits and losses made by recent investors.

  • It helps with an in-depth analysis of different strike prices.

  • It helps with option chain history analysis. You can see the growth of options over time.

  • Investors can determine premiums for different options contracts on the website of NSE.

  • Many investors rely on the index-option chain provided by NSE. The index-option chain includes macro-level indicators, which can be useful for investors.

  • Investors can understand the market sentiment with the NSE option chain and make decisions accordingly.

  • The NSE index-option chain helps understand sharp moves that might impact the prices.

Difference Between Puts and Calls

Before trading derivatives, it is essential to understand the dissimilarities between options and futures. Similarly, you must also understand the differences between call and put options. Here are the key dissimilarities:

Calls Puts

Call options give investors the right to purchase (no obligation) underlying securities at a given strike price on a future date.

Put options give investors the right to sell (no obligation) underlying securities at a given strike price on a future date.

When the price of the underlying asset increases, calls also increase in value.  Call options have a positive delta for the same rationale.

When the price of the underlying asset increases, the value of puts decreases. For the same rationale, puts have a negative delta.

The value of calls increases with an augment in the interest rate.

The value of puts decreases with a decline in the interest rate.

As the dividend date approaches, the value of calls decreases.

As the dividend date approaches, the value of puts increases.  

In a Nutshell

Options chains are mandatory for options investors. They can understand the market sentiment, implied volatility, price changes, and more with an option chain. You can visit the websites of trusted brokers and stock exchanges to access the latest options chains. Many brokers also provide options chains on trading platforms to help investors. Don’t forget to view options chains of the past to understand the changes in the value of calls and puts.

 



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