Friday, November 2, 2012

Open Interest Reading Technique

As per the teaching in futures & options articles, we know that when price is rising and open interest is also rising it is considered as bullish sign. we can expect price to go up in near future. On the otherhand when price is declining and open interest is rising that means it is bearish signal.

while the above may be true for futures....the same need to be applied to option data with a little caution.
let us see how to read options open interest data and find out if the underlying trend can be decoded...
in option we have 4 types of data on option snapshot page as shown on nse website, namely,
1. ITM CALL (Marked in yellow color)
2. OTM PUT
3. OTM CALL
4. ITM PUT (Marked in yellow color)


Highest concentration of trading is usually seen in ATM (AT-THE-MONEY) OTM CALL and OTM PUT. Most of the retail investors try to find trading opportunities in these ATM (OTM CALL / PUT) options. There is nothing wrong in that, provided you know which one to buy - whether to buy CALL or PUT?
Is there any tool to assist this decision? the answer is YES.
Just by one glance on the options data we can predict, with fair amount of accuracy, whether the next move is going to be bearish / bullish or just sideways.

Options data also tells us where the next resistance and support is likely to be and this can be put to our advantage if you can confirm the same with the help of supply / demand zones on the charts. This is a highly recommended - charts will give you the required foundation to trade with high amount of precision, provided you know how to spot supply & demand zones and the next likely orderflow (i.e. bullish/bearish orders).


I'm trying to give here my inputs on what to look at when you trade stocks based on options data. My favourite setup is to trade options when the stock comes very near to its major supply/demand zone as per the charts.

Let us assume, you have a stock XYZ which is trading very near its demand zone (support area). You know from your charts that the stock is going to pause here and bounce back....for 2 reasons....
1. The short sellers will start booking profits (by buying the stock) and
2. New buyers will start buying because the stock looks attractive now...

so there are 2 types of orderflow expected in this support area...both are buying orders...hence bullish for the stock, but does the option data suggest the same thing?

As I mentioned earlier, your ability to spot supply/demand zones on charts coupled with option data will give you high probability trades.
You have spotted a good demand zone, but what do you expect the option data to show here...

When the stock is trading at/near its demand zone, what I want to see in option data is the following....
1. I want to see the open interest declining in ITM/DITM PUTS and increasing in OTM PUTS. This signifies that DITM put writers have now started closing their open positions and writing (selling) OTM PUTS.
2. I also want to see the open interest decrease in DITM/ITM CALLS as price haults and increase as price rises. This signifies that short-sellers (Call writers) have started closing their open position and now new long positions are getting added as price increases.

When the above pattern is seen....then there is a good chance that the support will hold as all short-sellers seem to be booking their profit and new buyers are expected to enter the scene.

HOW TO TRADE OPTIONS WHEN THE STOCK IS AT DEMAND ZONE?
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For those of you who can afford the margin money, they can write OTM PUT, meaning SELL OTM PUT when the stock trades near its demand zone and enjoy the premium as time decay will work in your favour.

ELSE

You can Buy DITM CALL as you will have more than 75% chance of making money since DITM options have high amount of intrinsic value and less of time value.

..... if you wish to learn more about trading techniques with the help of charts & options data, please put a request on TradewithLS@gmail.com

Happy Trading !!!