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An option chain is a comprehensive data matrix that contains all the option contracts that are available for a particular security or index. This information is invaluable for traders who are seeking to determine the market sentiment. Indian traders are more inclined to examine the option chain metrics to identify any unusual trading activity that might indicate major price movements.
Each of the metrics in the option chain has a specific use and provides a unique perspective on market dynamics. Let’s discuss in this blog how to recognise unusual market activity using option chains.
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Open Interest (OI)
Open Interest (OI) is the total number of outstanding derivative contracts that are not settled or closed. If there are high OI concentrations at specific strike prices, it often serves as key support or resistance levels. A large OI build-up in OTM options on the NSE option chain at a particular strike level suggests that there is a higher participation and positioning at that strike level. Traders tend to use OI changes in combination with price, such as:
♦ Long Buildup: When both the price and the OI are increasing.
♦ Short Buildup: When the price is falling while the OI is increasing.
♦ Long Unwinding: Both the Price and OI are decreasing.
♦ Short Covering: When the price is increasing, and the OI is declining.
Retail traders can utilise these insights to make informed choices about their trades and modify their strategies in line with the market trend.
Volume spikes and institutional footprints
Trading volume indicates the immediate liquidity and intraday activity for a specific contract. One of the primary indicators of unusual activity is a sudden and unusual increase in trading volume.
This could be a sign that market players are actively taking new positions in anticipation of an upcoming event like earnings releases or macroeconomic policy decisions. Traders often use these large volume surges along with a change in OI to determine where smart money is going.
Implied Volatility (IV) expansions
Implied Volatility (IV) is the market’s price expectation of future price movements of the underlying asset. An increase in Implied Volatility (IV) during a calm market signals that the traders are willing to pay higher premiums for options, indicating the broader market expects a large price swing.
For example, if the IV of a particular stock’s put options suddenly skyrockets on the BSE option chain, it means there is a strong expectation of a downside movement, and smart traders are taking early steps to protect themselves.
Tracking Put-Call Ratio (PCR) anomalies
Put Call Ratio (PCR) is the ratio of the total number of put options traded to the total number of call options traded. If the PCR is high, it means that the market sentiment is bearish, and if the PCR is low, it means that the market sentiment is bullish.
However, extreme PCR readings are contrarian indicators. Suddenly, anomalous shifts in the PCR help traders spot potential market reversals, helping them avoid the pitfalls of making a purchase at the top and selling at the bottom.
Out-of-the-Money (OTM) accumulation
Institutional unusual activity is frequently spotted in deep OTM options. These options are not popular among conservative market participants because they have a low probability of expiring in the money. Therefore, when there is a sudden accumulation of volume and OI in far OTM strikes, it strongly implies that large players are expecting a price breakout.
Tracking this specific accumulation is one of the most reliable ways to spot early market positioning before the news reaches the public.
Conclusion
Reading an option chain is more than just about premium prices. By evaluating the above-mentioned metrics, traders can gain a deeper insight into market positioning and sentiment.
These indicators help traders make informed decisions, manage risks, and stay ahead of potential price movements by identifying unusual market activity.
