O P T I O N C H A I N A N A LY S I S F O R T R A D I N G

AN ANALYTICAL TOOL FOR TRADERS & INVESTORS

PRATHUISH P GOPINATHAN
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CONTENTS
Introduction to Option Chain and a message,
SO, what is option CHAIN?
Addressing WHOM?
Pure thought
Basics
Where can we find the option chain?
Basic Form
Reported Variables In Option Chain
variables in option
Underlying Asset/Index
Listing Option Based on Expiry/Strike
Expiry Based
Strike Based
Strikes
Open Interest
Open Interest in Laymen Terms
Open Interest Explained in the light of Stock & Futures
Change in Open Interest/ Change in OI
Volume
W MATTERS?
Implied Volatility
LTP & Change
Bid & Ask Qty and Price
Analysis of Option Chain
we named this Area as 1 and it belongs to ITM Call options
Area 2 represents Out of the money put option and here if
Area 3 – represents – Out of the money call option and here if you are seeing
Area 4 - represents – In the money put option and here if you are seeing
vested interest of option sellers
Open interest combo analysis
Using strike-based option chain
Conclusion
INTRODUCTION TO OPTION CHAIN AND A MESSAGE,
At some point in your trading journey, you will be introduced to
derivatives, once in, there is no coming back from that place. Though you
may fall a hundred times, taming this monster is more fun than continuing
playing in the status quo. In derivatives the monster comes as variables,
understanding the story each variable trying to tell us, becomes our routine.
If the understanding of the spot market involves 10 variables, then the
derivative market will throw a 100 at you to decide. Though a wild
generalization, the core idea remains the same.
When you are dealing in equity segments of the market, via buying and
selling stocks, shorting stocks, at the end the primary asset is still equity,
which is nearly perpetual, at least in the nearby horizon. The chances of a
good stock, turning completely into zero in value is very uncommon, in the
case of derivatives futures behave nearly in this light, but when the object
of attention is an option, this dimension changes. Options, unlike future, is a
second-order financial derivative, which has a complex relationship with
the underlying asset. The nuances of options are not the focus of this book;
the reader is expected to have a complete fundamental understanding of
options before you read further.
SO, WHAT IS OPTION CHAIN?
An option chain is a tabular data reporting done by exchanges to show,
what is happening to derivates’ in available expiries. In most exchanges
around the world, this data is freely available, though there may be
reporting delays, the most market offers this report free of cost in their live
report feeds or in related product report sections.
In certain markets, though report not available readily, you would have to
create a report in your trading system, it is time consuming to select
different strikes and parameters, but once done it can give you a
comprehensive view of the market than most technical analysis tools; on the
condition that are able to read and understand the stories numbers telling.
I prefer the second method of creating option chains, as the reported data is
fresher. Then there are third-party apps or analytical tool providers, who
may charge you another subscription fee to see this in a more visually
appealing and understandable way, but in long run, if you are able to tell the
story on your own, the better.
ADDRESSING WHOM?
I wrote this analysis of the option chain purely targeting traders, but if you
are an investor reading this, you can at times check the option chain to
determine, whether your portfolio needs hedging in short term or not, such
nuance decisions can be accurately done with help of option chains.
PURE THOUGHT
Finally, any amount of new novel information in the market is useful,
sometimes things we read would not make any sense right away, but in later
stages of our trading journey, this subtle information we learned will make a
huge difference, it happened to me a lot, I hope what you will learn
something useful here.
BASICS
The method of learning, I choose here is based on the first principle
thinking, or you can say learning from scratch. This means understanding
all the elements which make up an option chain, with that in mind try to
interpret the stories the option chain is telling through the numbers.
WHERE CAN WE FIND THE OPTION CHAIN?
With our friend google on our side, it is not that hard to find out, available
option chains on any asset. You will have to put in the right keyword and hit
the search button. Usually a search with keyword “asset name +option
chain “will directly give us the direct link to the page.
For example, if we are looking for nifty or bank nifty option chain, the
keyword will be simply
“nifty option chain” or
“bank nifty option chain”.
Even in the other global indices, this method would yield results. But in
certain index funds, finding it can be a little tricky. But as I said before,
most market offers option chain data at free of cost. Delay in reported
numbers is a problem, still at large most market offers with reporting delay
limited to 1-3 minutes.
BASIC FORM
Now let’s look at the basic form of option chain. Around the globe, all the
exchanges have adopted nearly the same tabular form of reporting option
chain. There are minor changes to reporting format, but overall, the
elements reported are the same.
Two commonly seen reporting formats are
Listing
Straddle
In listing method, options of same expiry are listed as long vertical table. A
sample vertical option chain is given below in fig1.
Fig1
Underlying
Asset
Calls
LT % Open Implied
Contract Time Strike LP Bid Ask Change Change Volume Interest Volatility
12:32
C-Code/Name PM 100 10.00 - - 5.00 2.00 10 10 10.00
1:32
C-Code/Name PM 150 50.00 - - 10.00 3.00 15 100 12.00
2:32
C-Code/Name PM 200 60.00 - - 15.00 5.00 10 150 15.00
3:32
C-Code/Name PM 250 70.00 - - 16.00 7.00 20 20 14.00
4:32
C-Code/Name PM 300 80.00 - - 15.00 10.00 25 30 10.00
Puts
LT % Open Implied
Contract Time Strike LP Bid Ask Change Change Volume Interest Volatility
12:32
C-Code/Name PM 100 10.00 - - 5.00 2.00 10 10 10.00
1:32
C-Code/Name PM 150 50.00 - - 10.00 3.00 15 100 12.00
2:32
C-Code/Name PM 200 60.00 - - 15.00 5.00 10 150 15.00
3:32
C-Code/Name PM 250 70.00 - - 16.00 7.00 20 20 14.00
In Straddle, both call option contracts and put option contracts are given
side by side. In general, this format is used to report option chains by
exchanges.
A sample is given below in fig2

Fig 2.
REPORTED VARIABLES IN OPTION CHAIN
Now let’s discuss the variables or the values reported in an option chain.
Though reporting format may change, the values reported are common to
both formats.
These variables are
Underlying Asset/Index
Contract
Last Trade Time/Last Price
Strike
Last Price or Last Traded Price
Bid Ask- Price & Quantity
Price Change
Change %
Volume
Open Interest
Implied Volatility
We will go through these in detail in the upcoming explanations, you can
check the chapters in the index available to view a specific particular to be
explained.
Also, along with this, in the money in calls and in the money, puts will be
highlighted with the same colors.
VARIABLES IN OPTION
Now that you have seen the basic format, let’s dive deep into each variable
in the basic format. For this explanation, I am choosing option chains
available at the NSE website as the example to explain further. The format
shown is a straddle format option chain. National Stock Exchange or NSE
is one of the foremost exchanges in India.

Fig 3

There will be a common head where it states it is an option that you

are seeing.>Ref 1 in Fig 3
Then next thing will be a selection criterion asking for which asset
you want to see the option chain:-2
In NSE you have index choice and scrip choice separately
shown, it is not uncommon to see them together in other
markets.
Then there will be a selection choice for expiry, or in a different
method you can also see option chain on a calendar spread basis for a
selected strike.:-3
Foremost we use expiry-based option chain.
Below that you will find the underlying asset name plus spot price
when the option chain was updated.
Below that you will find the reporting values starting from Call side
Open interest
Change in open interest
Volume
 Implied Volatility
LTP
Change in price
Bid -Quantity & Price
Ask Price & Quantity
Then strike price, afterwards all this will be repeated on the call side.
The values related to a particular option will be in single line parallel to the
strike.
If we choose 17000 strike, on the left hand side of 17000 line you will
see details regarding 17000 Call option, on right hand side you will
see details regarding 17000 put option.
Now let’s dive deep into these variables.
UNDERLYING ASSET/INDEX
As one knows option is a derivative instrument. All derivative instruments
derive value from the underlying. These underlying can be a stock or an
Index. In the option chain, underlying asset/Index means which asset the
reported options belong to. Or in a much simpler way, from which
financial/commodity asset the reported options below are derived.
Once you select the underlying, first criteria is selected.
On the NSE website, selection for index and stock are separately shown, as
option chain is available for stock as well, option chain can be seen for all
future and option enabled products.
If you want to select option chain of a particular stock, then you can select
this under symbol.
LISTING OPTION BASED ON EXPIRY/STRIKE
Now let’s talk about the next criteria, which we must select to see option.
Here we are offered two choices. We can go with expiry or strike. Let’s first
look into expiry-based option chain, then go for the strike based one.

EXPIRY BASED
As you know, options are contracts, and they have a specific lifetime. The
expiry means the day on which the options become exercisable. Beyond
that date, option have no power to be in the market. So, expiry act like a
validity checks on available options. And it is based on this expiry date,
traders and investors build their trades, strategies, and hedges. Usually this
is reported as a list of available expiries
Usually a drop down list
From this list you can choose the particular expiry you want to check the
option chain of.

This means
All strikes of same expiry will be shown as an option chain.
STRIKE BASED

Option chain based on strike – Calendar spread option chain. Here you can
choose a particular strike and its value will be reported in all available
expiries. You can choose to go with either expiry or strike price for listing
of options. Depending upon your specific requirement. As far as I
understood, strike-based option chains are most useful when you are
looking for a specific price point decision, while expiry-based option chain
focus more on directional cues.
This book will concentrate more on expiry-based option chain and strike-
based option chain will be used as an additional analytical tool.
STRIKES
Option contracts are standardized contracts with specific lot size and
exercise prices. Lot size will be same for all contracts, also, the exercise
prices will follow a specific gap rule This will be commonly applied to all
the available options. (For current and future expiries as well).
For example, in Banknifty Index, the gap followed between two
strikes are 100 points.
This means after 38000 Call, you will find 38100 call, not
38050 or 38010 call.
OPEN INTEREST
Out of all the aspects of the option chain analysis, understanding open
interest is the foremost important thing to learn.
So, what is open interest.
Options are essentially derivative contracts.
open interest means number of active contracts existing in the market.
Now let’s first try to understand it in a technical way, afterwards we can go
for layman explanations.
Open Interest means total number of contracts still outstanding.
It is the sum of all the long positions or equivalently, it is the sum of
all the short positions that has not been exercised, closed, or expired.
Let’s try to iterate open interest in a market scenario
Day Trading Activity Open Interest
Day 1 A buys & B sells – 1 Option Contract 0+1=1
Day 2 C buys & D sells – 4 Option Contracts 1+4=5
Day 3 A sell & D buy – 1 Option Contract 5-1=4
Day 4 E buys & C sells – 3 Contracts 4

In this table you can see 3 columns. In first column you can see the
date, in second column it explains what trading activity taken place in
market,
in the last column it is the number of open interests,
we will discuss it with an explanation on what happens to open
interest, based on the trading activity carried out in market.
In this example, A, B, C, D & E are market participants. Like options
sellers and buyers.
On day 1, when the option contracts are introduced into market, open
interest is 0,
as and when the first transaction is taken place,
 here when A buys & B sells 1 option contract, the open interest
becomes one.

On Day 2, when C, another participant buys, and D sells 4 contracts

then open interest becomes 5.
The four new contracts created are added to the existing number of active
contracts.
Thus, open interest becomes 1+4 =5
On day 3 A sells & D buys 1 option contract
Here A had a buy position, and it is closed with a sell position, D had a sell
position, and it is closed with a buy position. Thus, one contract gets closed.
So open interest drops 1 count,
From exiting 5 open contracts we must reduce the number of contracts
closed, here it is one.
Thus, we get 5-1 = 4, is the new open interest.
On day 4 E buys and C sells 3 contracts,
Here the participant E have no previous open positions in options,
while C had bought 4 option contracts on day 2. So, when E buys and
C sells 3 contracts, a new buy position is created with E, and C’s buy
positions are closed with sell to E.
No new option contracts are created, here mere transfer of contracts is
taken place. This means there is no change to open interest.
Thus, open interest remains like Day 3, at 4.
So, from this you can summarize the following,
When a contract is created it is counted as open interest.
When contract is transacted between buyers it will not impact open
interest.
When the initial seller buys the contract, then open interest will be
reduced.
In essence
Transaction between option sellers and option buyers increase or
decrease open interest.
Transaction between option buyers will not impact open interest
count.
OPEN INTEREST IN LAYMEN TERMS
Now let’s try to understand open interest in a much simpler explanation. In
this part, I am adding volume concept together because the nuance
difference between both can be understood easily, when done together.
Imagine there is an empty basket and a tray with 8 eggs in it.

The empty basket represents market, while eggs represent contracts, and
tray represents negotiations.
Now you moved 4 eggs into the basket from the tray

This means volume is 4

Open interest is 4
Now you moved 2 eggs back into the tray

Now volume is 6
 Open interest is 2
Then you moved 2 eggs inside the basket once.

Now volume is 8
Open interest is 2
Thus, the volume will be counted based on the transaction or as seen in the
example, it will be counted for every move, whether inside the basket or
travel back and forth between tray and basket.
But in open interest only active eggs in the basket are counted. As they are
the active contracts.
Summary of ideas
Open interest means number of active contracts in the market when
the option chain is reported. Number of contracts determines the
importance of a specific strike.
To easy understanding, think open interest as cash flow in and out of
the market. AS open interest increases more cash in flowing into the
market, while decreasing open interest means more cash is flowing
out of the market.
Increasing open interest typically means a trend is strengthening and
while losing open interest means trend is slowing down.
The idea is that traders are supporting the trend by entering the market
that increases the open interest. As traders lose faith in the trend, they
exit the market and open interest declines.
Open interest is one variable that many futures traders use in their
analysis of the markets used in conjunction with other analysis to
support trade decisions. Large changes in open interest can be an
indicator when certain participants are entering or leaving the
market and may give clues to market direction.
 OPEN INTEREST EXPLAINED IN THE LIGHT OF STOCK &
FUTURES
Open interest behaves in a different way in options than it is behaves in stock
futures & index futures.
Since we gone this deep, let’s dive a little deeper and understand the
implications of changes to open interest in stock futures and index futures
before we explain this variable specific to option chain analysis. Since there
day and night difference between the two. Understanding this will help you
analyze the market and use option chain analyzes on a better note.
So, this explanation is only for stock futures and index futures, not for options
or option chains.
In first column it is asset – it could be any stock future or index
future
In second column what is happening to price for the day is given
In third column what is the trend of the asset for last 1 month, or 3
months
In fourth column what is happening to open interest is given
In fifth column a cue, or what may happen because of these changes
are shown.

Price Trend Open Cue

Interest
Asset Rising Uptrend Increase Bullish
Rising Uptrend Decrease Bearish
Falling Downtrend Increase Bearish
Falling Downtrend Decrease New Fall
Or Market Bottom
Falling Market top Increase Bearish/Panic Selling
Iterations from table.
1. In a situation where price is rising in an already up trending market,
and you are seeing increasing open interest, this can be a sign of
another bullish run.
2. And if open interest is decreasing in this situation, this can be sign of
market topping or upcoming bearish run.
3. Where price is already in down trend and falling, along with this you
are seeing open interest is increasing, this can be a sign of another
bearish run.
4. If in such situation if you are seeing open interest decreasing, then
market is bottoming up. Or in some cases it can be start of fresh fall.
5. Panic selling can be confirmed with a situation where price is falling
from market top, along with this you may see drastic increase in open
interest.
 CHANGE IN OPEN INTEREST/ CHANGE IN OI
As the head says
Changes to open interest is noted here,
as per my experience in dealing with option chain,
this is the single most important variable to look for.
Any change in OI can direct us towards cues that will help us
determine market direction in the upcoming session.
This information is valuable in multifold as a trader.
 VOLUME
The idea of volume is already explained, but let’s go through it again.
While open interest counts number of active contracts, volume counts
all the transaction that happened in a particular option for the day.
Generally, securities with more daily volume are more liquid than
those without since they are more "active".
Volume is an important indicator in technical analysis because it is
used to measure the relative significance of a market move and the
instrument.
In its simplest form it means the number of times an instrument traded
between two points in time.
When it comes to option the volume consists of the following
Options created
Options closed
Existing options traded

WHY VOLUME MATTERS?

Noting down the volume in each option will help us identify where the
market as large expects something to happen. This will give us a directional
view of the market for a short period. But it’s a continuous analysis tool;
hence its meaning changes with every update.
In general, the following can be interpreted from the volume levels
It shows the number of shares traded in stock market
It usually helps us to identify the trend.
Now let’s analyze some common situations related to volume. It works not
only in options it works across all the financial instruments.
LTP drops + Volume Increase
Downtrend is strengthening
LTP Up + Volume Increases
Uptrend is strengthening.
Now in the opposite way, when a trend is weakening you can find the
following actions in market
LTP UP + Volume Low
LTP DOWN + Volume Low
Decreased volume can also indicate first signs of reverse trend being
formed.
 IMPLIED VOLATILITY
When we use the term volatility, it often refers to historical volatility, and
we do not always say historical volatility as it assumed to be historical
volatility, when volatility is mentioned as a single term.
Implied volatility is the volatility of future, or it is the expected future
volatility.
It is even funnier how IV is calculated.
You must have heard about BSM of Option Pricing.
This BSM of Option Pricing has “volatility” as one of the variables
in the equation.
Now we get the price of option in market by the play of demand and
supply.
we have price, now we can reverse apply the price in the equation to
find the variables in the equation, provided we know all other
variables than volatility.
To make it even simpler
Suppose x+y=5
And we know y= 2
Then we can easily arrive at x = 5-2 = 3
Here, in layman terms imagine 5 being the option price y being
the known variable in BSM and x being volatility.
So practically we arrived at volatility value which is of future. This
future volatility is known as implied volatility.
Generally
Implied volatility is the market's forecast of a likely movement in a
security's price. IV is often used to price options contracts were high
implied volatility results in options with higher premiums and vice versa.
Supply and demand and time value are major determining factors for
calculating implied volatility. Implied volatility usually increases in bearish
markets and decreases when the market is bullish. This is due to left skew
or fat tail nature of stock market. We will discuss this in detail in another
video. Finally, IV is purely price based.
 LTP & CHANGE
LTP
Last traded price means the price of the last trade based on the time
when option chain was updated.
This often is different from live market, as most time option chains
are reported with a delay,
This can be different for live feed option chains.

Change
Change here means how much the price of the option strike have
changed from previous close.
 BID & ASK QTY AND PRICE

Bid Qty Bid Price Ask Qty Ask Price

Buyers Sellers

Bid qty means the quantity buyers are willing to buy

Bid price is the price at which they are willing to buy that quantity
Ask Qty means the quantity sellers are willing to sell
Ask price is the price at which they are willing to sell that quantity
A bid-ask spread is a difference between the highest price that a buyer is
willing to pay for an asset and the lowest price that a seller is willing to
accept.
The spread is the transaction cost. Price takers buy at the asking price
and sell at the bid price, but the market maker buys at the bid price
and sells at the asking price.
Coming back to bid & ask,
Now let’s put this into a real-life example,
like how it plays out in our decision making
An option has bid price 9 and ask price 12, the spread is 12-9 = 3
Another option has bid 10 and ask price 14, spread 14-10 = 4
In this we should go for the first option one with lower spread. Because
tighter the spread the better. Tighter the spread better the liquidity in that
particular asset. The bid represents demand for an asset, and the ask
represents supply for the asset. The bid-ask spread is the de facto measure
of market liquidity. As such more liquid an asset is, the tighter or lower the
spread becomes.
To be frank, I never gave much importance to the bid ask spread reported in
option chains. Especially in delayed chains like Nifty and Banknifty. Rather
whenever I am interested in a specific strike option, I usually see the market
order depth in the watch list of trading interface. As they are more accurate.
 ANALYSIS OF OPTION CHAIN
Now that we have went through all the variables that make up the option
chains, let’s get to the core of the option chain analysis.
The first method of option chain analysis we are going to do is on the
expiry-based straddle option chain, or to be more precise, the option chain
we usually see in nifty & banknifty.
Option chains can be analyzed on different variables reported in option
chain, but let’s focus on open interest & change in open interest.
Here you must understand one thing, I am very skewed towards open
interest data, as I have seen more success cues from analyzing open
interest data than any other variables reported in option chains. This
simply means, from here on what you are going to hear is very biased on
my convictions.
First, let’s break down the option chain reported in the straddle method into
four sectors
Call in the Put out of the money
money 2
1
Call out of the Put in the money
money 4
3

One the left side we have Call ITM & Call out of the money,
On the right side we have Put OTM & Put ITM
We will name Call ITM, this much portion as 1
Put out of the money, this much as 2
Call out of the money, this as 3
And Put in the money as 4
Now each of this sector can be analyzed alone as well as together. First let’s
start with each section alone, once we understood that then we can move on
to analyzing them together. Imagine this is the option chain, here we have
the spot line.
WE NAMED THIS AREA AS 1 AND IT BELONGS TO ITM CALL
OPTIONS
1. If you are seeing OI increasing, we can have two impending situations
1. Market is stagnating and
2. A downside can be expected
2. If you are seeing OI Decreasing
Market is trying to test new highs
1. An upside can be expected

AREA 2 REPRESENTS OUT OF THE MONEY PUT OPTION AND

HERE IF
1. OI increasing
1. Market is bottoming up. It’s building a strong base
2. Chances of market going down from here is small
3. An upside can also be expected
2. OI Decreasing
1. Market is trying to test the new downside.
2. Chance of market going down is now increased
3. A downside can be expected

AREA 3 – REPRESENTS – OUT OF THE MONEY CALL OPTION AND

HERE IF YOU ARE SEEING
1. OI increasing, we can conclude
1. Market is not seeing an upside in near future
2. Market is expected to remain at spot, or a downside can be
expected
2. And if
3. OI Decreasing
1. Market is trying to test new heights
2. An upside can be expected
AREA 4 - REPRESENTS – IN THE MONEY PUT OPTION AND HERE
IF YOU ARE SEEING
1. OI increasing
1. Market is expected to make a new high
2. An upside can be expected
2. OI Decreasing
1. Market is expected to make a new low
2. A downside can be expected
Before we go on analyzing open interest further, let’s discuss another important aspect of
concentrating on open interest count,
 VESTED INTEREST OF OPTION SELLERS
see, Option sellers have significant influence in controlling the market
direction in the short term. So, finding out what they think is a good idea to
know, where the market is skewed towards, in the short run.
To find vested interest of option sellers in a single option, follow these
steps
Find out the margin requirement for selling an option – be it put or
call- let’s call this value A
Now count the open interest in that option, let’s call this value B
Multiply AXB =C
C is the vested value of option sellers in particular options.
More value they put in one option the more likely the option expires
worthless.
So, the key is trying to find out the strikes where vested interest of
option sellers is minimal and
Which options where option sellers are leaving the market by closing
their open positions.
But note that, it must be done across the strikes within a range of 10
strikes up and 10 strikes down, not more than that.
Considering deep out of the money options will distort the findings,
giving you false positives.
 OPEN INTEREST COMBO ANALYSIS
These are the common combination of changes in open interest seen together.
AREA
1 + - + - + + + -
AREA
2 + - - + + + + -
AREA
3 + - + - + - - +
AREA
4 + - - + - - + +
MARKET
CUE FLAT FLAT CONFIDENT CONFIDENT MARKET INDIFFERENT
CORRECTION
INDIFFERENT
WAITING FOR WAITING FOR
CORRECTION
FAR FAR A A
DOWNTREND UPTREND ON ON UPSIDE
VOLATILE VOLATILE REGULATORY REGULATORY
DOWNSIDE
MOVE MOVE

Other generic cues from option chain

Calls with highest open interest will act as the resistance
Puts with highest open interest will act as the support
This is one of the common interpretations done with open chain data.
 USING STRIKE-BASED OPTION CHAIN

After cueing in on expiry-based option chain and if you want to specifically

create calendar spread strategies or generally know what is expected market
move in coming weeks or months. Strike based option chain can give you
confirmation on the directional cues you got from expiry-based option
chain, for coming times.
 CONCLUSION
End of the day, what really matters is whether you can make money
in the market or not. No matter whatever the analysis you do if you cannot
materialize the knowledge into hard cash. Then the whole effort is
pointless.
The following are some guidelines in using the information gathered from
the option chain.
First, do not use option chains alone for interpreting the market. I
believe you are not dumb enough to do that.
Interpreting option chains will help us learn the vested interest in the
market of bigger players.
This direction cue along with news, technical analysis, or fundamental
analysis will give us a statistical edge, and it will make, all the
difference.