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Friday 27 Dec. 2024
Investors and traders who want to enter the derivatives market often encounter the term ‘option chain’. This important tool is used to analyse and make informed decisions in the options market. In this article, we will learn more about options chains and their workings.
Understanding Option Chains
A listing that consists of information about all the available option contracts for a particular asset is known as an option chain. The option chain is also referred to as the option matrix. It provides traders and investors with a detailed idea about the market’s sentiments by presenting:
- Prices of the option (also called premium).
- The volume of the trade
- Open interest (The number of existing contracts in the market)
- Call and Put options and other important data.
An option chain is arranged in a table format to facilitate traders’ comparison and analysis of the available options.
Components of an Option Chain
An option chain has various components. Some of them are explained below.
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Underlying Asset
Every option that is listed in the option chain is based on an underlying asset such as stocks or a market index. This means an option can be based on the stock of a company or the Nifty50 index.
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Expiration Date
The last day beyond which traders cannot trade a particular option is called the expiration date. It is important to note these values since they directly affect the value of the options.
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Strike Prices
The strike price is the price at which investors can choose to buy or sell the underlying asset of the contract. To allow investors to choose their preferred prices, an option chain shows different strike prices.
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Option Types
There are two types of options, call and put. The call option allows the investor or trader to buy the underlying asset at a price before it expires. Whereas, the put option allows them to sell the underlying asset before it expires.
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Premium
The premium is the amount you pay to buy an option contract. It has a bid and an ask price. The highest price a buyer is willing to pay is known as the bid price. On the other hand, the ask price is the lowest price the seller is willing to receive.
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Volume and Open Interest
Volume is useful to depict the number of contracts that have been traded on a particular day. If the volume is higher, this means that more people have traded that particular option. On the other hand, open interest is the total number of contracts that are still active and are not settled. Both these numbers are useful for understanding the market activity.
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Implied Volatility (IV)
Implied Volatility indicates the market volatility. It also helps traders and investors calculate probability.
Working of the Option Chain
Investors and traders must be able to read the option chain to have the ability to analyse the data that is arranged in tabular form with separate sections for put and call options. Here is how an option chain works:
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Rows and Columns
The rows in an option chain show different strike prices and the columns display bid prices, ask prices, and open interest.
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Price Analysis
The market sentiments and the volatility can be understood by traders and investors after looking at the bid and ask prices. High liquidity may be indicated with the help of small differences between these two prices.
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Option Choosing
Traders can select options that align with their trading strategies by analysing data on expiration dates, strike prices, volume, and open interest.
Tips For Using an Option Chain
Using the option chain can seem daunting. Here are some of the tips that could help you while trading options.
- For easy trading, pay attention to contracts that have a high volume and open interest.
- High IV generally means high premiums. Make sure to take this fact into account while trading.
- To make better decisions, make sure to do technical analysis while studying the option chain.
- News and major global events can largely influence the market. So make sure to stay updated on the current events.
Traders and investors who want to trade in options must open Demat account, and then activate your trading account.
Conclusion
For traders and investors who are involved in options trading, options charts are a valuable tool. This is because it not only provides detailed information about the available contracts but also shows important components of an option chart such as strike price, expiration date, bid and ask prices, trade volumes, and open interest. By understanding how to analyse these components, traders can improve their trading strategy to suit their investment goals.
