Here is a simple intraday trading setup based on Option Chain analysis technique. The chart timeframe for this intraday strategy is 3 minutes.
You can use this strategy to trade stocks and indices that are part of the derivatives segmentFurther, you can use any instrument to trade it i.e. cash (equity shares), futures or options. Also, with this setup you can trade in a bullish as well as a bearish market.
We will use Option Chain to identify a 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 the 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 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 open interest column indicates 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. We already know how to use the above strategy to buy puts. In this article, let's look at a call writing(selling) 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 me walk you through step 1 analysis with the help of an example.
We will 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 is indicating that call writers are creating positions at this specific strike price and don’t want the Nifty to go above the level of 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 open 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, the zones marked in black box. It also formed a triple top price action pattern where price rejects from a particular zone not once but 3 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.
Since we are particularly talking about Option writing in this article, selecting the right strike price to trade becomes very important. The chart and the option data indicates bearish movement from 17600 zones. If we are expecting a bearish movement, our focus should be on selling call options. Since the ATM(at the money) strike price is 17600 (based on the current market price of 17582) we have to go 3 strike prices above(slightly deep OTM - out of the money) and trade that particular strike price. In our case it will be 17900 call option (3 strikes above ATM) Nifty has a strike price difference of 50 points whereas Bank Nifty has a strike price difference of 100 points. For Nifty, we have to ignore the 50’s strike price and only look at the multiple of 100’s in deciding the strike to trade. We will sell 17900 call options near our entry point of 17582.
Option writing will require higher capital (close to a lakh) as compared to option buying whether we do Intraday or Delivery (Positional). Advantage of Option Writing is that after we get our entry, if the fall is sharp or the fall is dull(sideways), the chances of coming out of the trade profitably is much higher. Whereas in option buying, the fall has to be quick and sharp since option buyers fight time. If we buy an option and the movement goes sideways, it starts decaying the premiums.
Now, let’s move to stop loss. 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 used is 3 minutes, we will aim for a risk- reward of 1:1. In our example the risk being 28 points, we will aim for a target of 28 points too 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 17900 call option position and come out with profit.
We hope this Option Chain strategy was simple and easy to understand.
Stay tuned with us, a lot of interesting articles on trading strategies will be coming your way soon!