Derivatives

How to predict option trends

Akhil Nallamuthu | Updated on February 27, 2021

F&O analysis reports often talk about more call writing happening or more puts being added on long side at a strike price etc. to predict some trend. As the total number of long positions will be equal to total number of short positions at any given time, do these kind of statements make any sense?

- Raju P.K

It is a common practice to predict the trend of an underlying by using certain metrics of derivative contracts and a very important number that many traders track is Open Interest (OI). When OI goes up by one contract that means one new buyer and one new seller have entered, be it a futures contract or an options contract. In that sense, the number of buyers and sellers are equal here. However, it is important to understand that the number of OI per se cannot lend us any clue on the direction. It should be seen in conjunction with the price movement.

For example, consider a 1000-strike call option of Stock A which is trading at ₹100 and the outstanding OI is at 500. Suppose a transaction happens at ₹101 involving a new buyer and a new seller. This means, someone has sold the call at ₹101 whereas the other trader has bought at that price. Now, OI increases to 501. Similarly, another set of traders transact at ₹105 and OI increase to 502. Here, although there are sellers and buyers, the price has gone up because call buyers are ready to pay higher price and are pushing it upwards. In this case, the buyers are winning, and it will generally be referred to as bullish build-up in this 1000-strike call option.

 

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Published on February 27, 2021
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