Here is a simple intraday trading setup based on the Option Chain analysis technique. The chart timeframe for this intraday strategy is 3 minutes.
You can use this setup to trade stocks and indices that are part of the derivatives segment.. Further, you can use any instrument to trade it, i.e. cash (equity shares), futures or options. Also, with this strategy, you can trade in a bullish as well as a bearish market.
We will use Option Chain to identify resistance or support and a candlestick pattern to confirm the analysis and trade accordingly. Hence this strategy is going to be a combination of both Option Chain and a candlestick pattern.
Traders typically analyze option chain as data of writers (sellers). Put writers are bullish, whereas call writers are bearish. If put writers are more than the call writers, then the trend is most likely to be bullish, and if the call writers are more than the put writers, then the trend is most likely to be bearish.
The strike price with the highest figure on the call side open interest column and change in open interest column indicates presence of call writers in that specific strike price which means the call writers are not expecting the price to go above that particular strike price. The call writers have created a resistance at that strike price.
The strike price with the highest figure on the put side open interest column and change in the open interest column indicates the presence of put writers in that specific strike price, which means the put writers are not expecting the price to go below that strike price. The put writers have created support at that strike price.
In this article, we will be using Option Chain to identify a resistance (heavy call writer's presence) in the live market and look for a bearish candlestick pattern to confirm the analysis and take a trade.
Let’s understand the step by step process as to how we analyze and trade this strategy. At the moment, let's look at a put buying strategy using option chain resistance.
Steps of the setup:
We’re analysing the Nifty spot chart in the example below.
Step 1: We have to look for resistance using the option chain in the live market. As mentioned above, we have to see the strike price with the highest figure on the call side open interest column and change in the open interest column.
Let’s move to Step 1 analysis with the help of an example.
We use nseindia.com for option chain analysis. The above data gets updated every 5 mins in the live market. The above option chain data is of Nifty 22nd September (23rd September expiry)
The first column is the OI(Open Interest) column and the second column is the Change in OI (Change in Open Interest) column. We can clearly see that the 17600 strike price (marked in a black box) has the highest open interest and change in open interest. This indicates that call writers are creating positions at this specific strike price and don’t want the Nifty to go above 17600.
Now, we will look at the price charts and look for some bearish patterns(both price and candlestick) near 17600.
Step 2. We will look at the Nifty spot 22nd September 3 minutes chart and look for a bearish candlestick pattern near 17600. We will look at a price chart on Upstox pro web platform.
In the chart above we can see the price kept moving down everytime it came near 17600-17610 zones marked in black box. It also formed a triple top price action pattern where price rejects from a particular zone not once but three times before eventually going down even further.
The C point(third high) of the triple top pattern is when we get a bearish engulfing pattern which confirms that the price can take resistance at 17600 and go south.
Step 3 : Let's understand with the help of a chart as to what price do we enter, where do we keep our stop loss and when do we exit (target)
You can see the GREEN line (17581.96) that's where the bearish engulfing pattern was formed after the triple top pattern .That is our entry point. We will enter around those levels at 17582. Since Nifty spot can’t be traded, you can look to trade Nifty futures or options. If you choose to trade options, one way to go about it is that you can buy an ATM (at the money) strike price put option to trade. The market price is 17582 in our example and the nearest strike price seems to be 17600 put option. So, 17600 becomes our ATM strike (at the money). Since it’s an intraday trade, you can go for weekly expiry rather than a monthly expiry contract.
Coming to stop loss now. You can see the RED line (17609.74) which is the third high point of the triple top pattern . That's 28 points above the entry point of 17582. If the Nifty goes up and hits 17609 (our stop loss) we will take a small loss and exit from our position.
Since it’s an intraday and a quick trade, the timeframe being 3 minutes, we will aim for a risk to reward of 1:1. In our example the risk being 28 points, we will aim for a target of 28 points from our entry price which comes to 17554 (17582- 28)
You can see the PURPLE line (17554). Once our price hits 17554, we will exit our 17600 put option position and come out with our profit.
We hope this Option Chain technique strategy was simple and easy to understand.
We hope this was fun. We’ll come up with an article on how to use the same strategy to identify a bullish setup and also how you can use the same strategy to sell options
Until then, happy trading!