Covered call (long stock + short call)

How the option price is formed, Basics Of Options Trading Explained

Up Bullish Indicates new long positions are how lehu and makes money on the Internet built and is likely to support the current up trend in price Up Down Cautiously bullish Indicates at short covering and that the rally could fizzle out once the short covering ends Down Up Bearish Indicates new short positions are being built and is likely to support the current down trend in price Down Cautiously bearish Indicates at long unwinding and that the decline could halt once the long unwinding ends In brief, open interest that confirms the price action is supportive of the move in the price and indicates that the current trend is healthy and is likely to continue.

On the other hand, open interest that does not confirm the price action indicates that the trend is on a weaker footing and could how the option price is formed run out of steam.

Understanding the elements of the NSE Option Chain Before proceeding with the main part of this chapter, which is understanding how to read and analyse an option chain, let us first understand the elements of the option chain.

Swaps Pricing Basics Different types of derivatives have different pricing mechanisms. A derivative is simply a financial contract with a value that is based on some underlying asset e. The most common derivative types are futures contracts, forward contractsoptions and swaps.

As said earlier in this chapter, we will be referring to the option chain that is available on the NSE website. Following are the steps to look at the NSE option chain: Visit www. Once the drop down list of items appears, select Nifty, as shown in the screenshot below. This will open the quote page for Nifty contracts.

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Now select the Option Chain tab, as shown in the image below. This will open the Option Chain page for Nifty. Once the Option Chain page opens, the user can change the expiry or the strike price of the underlying, if he or she wants to. Also notice that the latest underlying price is mentioned on the right.

How is the price of a derivative determined?

Let us change the expiry date from the weekly expiry to the monthly expiry. Now the Nifty option chain having the monthly expiration will appear on the screen. Below mentioned is a part of the screenshot of the option chain. In a similar way, the user can also look at the option chain for other index options as well as for various stock options that are traded on the NSE.

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Besides the Nifty, Bank Nifty index is also heavily traded on the option segment. Among stocks too, there are various option contracts that are available for trading. However, before trading stock options, have a very close look on the volume and open interest statistics of stock options, as only a handful of them are liquid.

Options Contract

Now that we know how to search for the Option Chain of an underlying that is traded on the NSE, let us decipher each element of the Option Chain. Again, let us paste a portion of the Option Chain screenshot that we posted above.

As you can see in the above screenshot, the Option Chain is split in two parts around the central portion, which is the strike price: Calls on the left and Puts on the right.

Stock Options Explained

As can be seen, there are various strike price at which options are traded for a particular expiration.

There are various statistics that are displayed for each of the option type. Let us now start talking about each of them.

  • An options contract is an agreement between two parties to facilitate a potential transaction on the underlying security at a preset price, referred to as the strike priceprior to the expiration date.
  • Writers of covered calls typically forecast that the stock price will not fall below the break-even point before expiration.
  • 100 profit strategy on binary options
  • Intrinsic value[ edit ] The intrinsic value is the difference between the underlying spot price and the strike price, to the extent that this is in favor of the option holder.
  • Basics Of Options Trading Explained
  • School of Stocks - Reading Option Chain using Volume & OI

The green icon that appearsfor each strike price at the extreme end of each option type displays the intraday chart of the option for the respective strike price. Both the Call and the Put option for the said strike are displayed in the chart, as shown in the image below: The OI tab displays the Open Interest statistics for each strike price and for each of the option type.

As a rule, the higher the OI, the more liquid the option contract is, and vice versa. The change in OI tab displays the change in Open Interest that took place during the day for each strike price and for each of the option type.

Covered call (long stock + short call)

A positive value indicates an increase in Open Interest for that day, while a negative value indicates a decrease. The Volume tab displays the total contracts traded during the day for each strike price and for each of the option type.

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As a rule, the higher the volume, the more liquid the option contract is, and vice versa. The IV tab displays the Implied Volatility for each strike price and for each of the how the option price is formed type. This essentially tells how volatile the respective option contract is. As a rule, the higher the IV, the more volatile is the option price for a given change in the underlying price, and vice versa.

A negative value displayed in red means that the price has declined from the previous day, while a positive value displayed in green means that the price has advanced from the previous day.

Reading Option Chain using Volume & OI

The Bid Quantity tab displays the number of buy orders i. The Bid Price tab displays the price that buyers are willing to how the option price is formed to buy the option of a particular strike price. The Ask Price tab displays the price that sellers are willing to accept to sell the option of a particular strike price.

The Ask Quantity tab displays the number of sell orders i.

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If you observe the Option Chain, you will see that around half of the Calls and around half of the Puts are shaded in light brown, while the remaining are non-shaded i. You might wonder what this means. Well, if you notice, you will see that the shaded Calls options are at the top half, while the shaded Put options are at the bottom half. These are the options that are ITM.

Meanwhile, the options that are not shaded are OTM how the option price is formed.

Basics Of Options Trading Explained

For instance, look at the below screenshot. For this option chain, the underlying price of Nifty at the time of writing was So, at the time of writing, Call options that have strike price below are ITM and as such are shaded in light brown, while those that have strike price above are OTM and as such are non-shaded.

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Similarly, Put options that have strike price above are ITM and as such are shaded in light brown, while those that have strike price below are OTM and as such as non-shaded. Keep in mind that the colour of the option chain does not remain fixed.

Valuation of options

Instead, as the underlying price changes, the colour of the option chain can also change when a few options move ITM while a few others move OTM. Reading and Analysing an Options Chain Now that we understand each element of an Option Chain, it is time to discuss about the main part of this chapter: How to read, interpret, and analyse an Option Chain.

  1. In this way, delta and gamma of an option changes with the change in the stock price.
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  3. Option trade execution date
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  8. Valuation of options - Wikipedia

Being able to do this is very crucial when trading options because it lets one understand the structure of the underlying in terms of its option positioning. It enables one to know at what level an underlying could find support or resistance as well as gauge what would happen once a key support or resistance is convincingly broken.