What is Option Chain: Meaning, Components, Example

Option chains are crucial for traders as they provide valuable insights into market sentiment, potential price moves, and liquidity. They also help traders assess their risk-to-reward ratio when entering or exiting positions in derivatives

What is an Option Chain?

An Option Chain is a visual representation of an organized table showing all the available derivative option contracts in the Call and Put options for their specific underlying asset like stocks, indices, or commodities. It provides in-detailed information on each option contract present in all different expiry periods available to trade in the market, including their strike prices, and the key statistics such as (OI) open interest, volume, implied volatility (IV), and LTP (Last Traded Price), PCR (put call ratio).

What is the historical Option Chain?

A Historical Option Chain is a visual representation of historical data records of options, including their strike prices, open interest, and volume of past dates. This data is extremely valuable as it gives information to the traders to analyze and interpret how the market behaved in the past on events or special market days and helps identify potential trends.

It can be mostly useful for back-testing your trading strategies. Historical data can help traders understand how market events and economic factors affected the options pricing movement and sentiment in previous trading periods. Analyzing the historical data of the option chain before a major earnings announcement could provide good insights into how volatility behaved around similar events over time, liquidation changes in certain strikes, and how price movements aligned with volatility metrics.

How to Read an Options Chart?

Reading an Options Chart effectively requires understanding the following components.

1. Strike Price: The price at which the trader of the option can buy Call or sell Put of the underlying asset. Option chains provide strike prices in intervals in indices, like 50 in Nifty, 100 In Bank Nifty, etc...
2. Premium: The price of the option itself. It represents the cost of purchasing the option contract. The premium changes based on the CMP of the underlying asset, time to expiry, and implied volatility.
3. Open Interest (OI): This is the total number of outstanding contracts including both Call and Put which have not been closed or exercised. A rising OI defines that a new position in that contract has been opened, and a falling OI indicates that positions are being closed.
4. Volume: Volume states the number of option contracts traded during the trading session. A high volume generally indicates high open interest in the option, while a low volume could indicate limited market activity or liquidity.
5. Implied Volatility (IV): This Implied Volatility reflects the market’s expectations for future volatility of the underlying asset. High IV indicates a market expecting large price fluctuations, while low IV reflects expectations of less movement. Most of the traders use IV to estimate whether the options are overpriced or underpriced.
6. Bid-Ask Spread: The bid price is the highest price a buyer is willing to pay for the option, while the asking price is the lowest the seller is willing to sell. The Bid-Ask Spread gives insights into market liquidity.

By carefully understanding these elements, traders can gather information about the strength of trends, expected price fluctuations, and investor sentiment toward a stock or index.

Components of Options Chain Chart

The Options Chain Chart includes the following key components:

1. Strike Price: As mentioned, this is the agreed-upon price at which the option can be exercised. The chain will include strike prices above and below the current price of the underlying asset, with more distant strikes providing insights into potential movements for the traders.
2. Premium: This is the price traders willing to pay to acquire the option contract. It fluctuates throughout the trading session in the market depending on changes in the underlying asset’s price, time to expiration, implied volatility, and other factors.
3. Open Interest: This figure shows how many contracts remain open that are unexercised in the market. An increase in open interest typically signals a continuation of the current trend, while a decrease may indicate that the trend is weakening or reversal.
4. Volume: Volume indicates the level of trading activity. High volume in an option typically indicates strong interest, suggesting that the market is active and that liquidity is good.
5. Implied Volatility: A measure of the market's expectation of future volatility. IV directly impacts the premium of options. If IV is high, premiums tend to be higher because traders are anticipating significant price fluctuations.
6. Last Traded Price: The last traded price is the most recently traded price at which the option contract was bought or sold. LTP helps traders identify the most up-to-date market price value for an option.
7. Bid and Ask: The Bid Price is the maximum price buyers are willing to pay, while the Ask Price is the minimum price sellers are willing to accept. The difference between the two is known as the Bid-Ask Spread, which can provide clues to liquidity.

What is OI in Option Chain?

OI (Open Interest) is a critical calculation metric that measures the total number of outstanding open contracts that have not yet been closed or exercised. Open interest shows an in-depth understanding of market participation.

• Rising OI: Raising OI indicates that new positions are being opened, signaling a continuation of the trend.
• Declining OI: Declining OI suggests that traders are closing their positions, which could indicate that the current trend is weakening.

What is Change in Open Interest in Option Chain?

Change in the Open Interest represents the difference between the current day’s open interest and the previous day’s open interest. This helps traders to identify the movement of new positions in the market. 

If OI is increasing, it may indicate the initiation of new positions and a potential continuation of the market trend. Conversely, a decrease in OI indicates position closure or liquidation, signaling possible trend reversal or fading momentum in the market.

What is IV (Implied Volatility) in the Options Chain?

IV, Implied Volatility in an option chain refers to an estimate of the future volatility of the underlying asset. It reflects the market's consensus on the likelihood of price movement of assets in the future. High implied volatility implies in options that the traders are expecting significant price movement, which raises the premiums of options rapidly. 

On the other hand, low IV suggests lower expectations of price movement and results in cheaper price value in options.

What is LTP in the Options Chain?

The last Traded Price in options is the most recent price at which an option contract was traded. It helps traders to understand the real-time market value of an option during market hours. 

The LTP fluctuates constantly as options are traded in the stock exchanges, and it can be significantly impacted by price changes in their underlying asset’s price and changes in implied volatility.

What is Volume in Option Chain?

Volume in an option chain refers to the total number of contracts traded during a specific time, typically during the trading day in a certain option contract. Volume is considered an important indicator of market activities and liquidity. 

Higher volume always indicates that the option is liquid and that there is enough interest for traders to enter and exit positions easily in the market. Lower volume, on the other hand, could indicate limited liquidity and potential difficulties in executing trades at bidding prices.

What is Net Change in Option Chain?

The Net Change represents the difference in the price of an option from one trading session to the next. It shows whether the option price has risen or fallen and by how much percentage. A significant net change in options can indicate strong market sentiment toward those underlying assets.

What is the Bid-Ask Price in the Options Chain?

The Bid Price is the maximum price a buyer is willing to pay for an option, and the Ask Price is the minimum price a seller is willing to accept. The Bid-Ask Spread is the difference between these two prices. A narrow spread indicates a liquid and active market, while a widespread always suggests lower liquidity and less trading activity in the market. Traders need to be mindful of this spread, as it impacts the execution of trades.

What is the Bid & Ask Quantity in the Options Chain?

Bid Quantity: refers to the number of contracts that buyers are willing to purchase at the current bid price. It shows the level of demand for the option at that specific price.

Ask Quantity: is the number of contracts that sellers are willing to offer at the ask price. These quantities give traders insight into market sentiment and the potential for price movement.

Significance of NSE Option Chain

The NSE Option Chain is an essential tool for Indian traders who wish to trade the options present on the National Stock Exchange (NSE). It provides free real-time data for various stocks, indices, and ETFs listed on the exchange. The information includes strike prices, open interest, volume, and implied volatility, among other metrics. 

By analyzing the data provided by the NSE Option Chain, traders can determine the market sentiment, track large institutional trades, and identify areas of support and resistance.

Uses of Option Chain

1. Market Sentiment Analysis: traders can understand the market sentiment by analyzing volume, open interest, and implied volatility, to gauge the market’s sentiment towards an asset.
2. Volatility Forecasting: Implied volatility is a kind of indicator for traders that gives insights into potential future price movements. A sharp rise in IV can suggest upcoming price swings.
3. Liquidity Analysis: The Bid-Ask spread, and Volume indicate how liquid an option is. Traders prefer liquid options to ensure quick execution.
4. Trend Confirmation: By observing changes in open interest and volume, traders can confirm trends and detect potential reversals.

Difference Between Calls and Puts

Call Options: call options give the call holder the right to buy the underlying asset at a set price which is called a strike price by a specified expiration date. Calls are beneficial if the trader expects the asset's price to rise.

Put Options: The put option gives the holder the right to sell the underlying asset at a set price. Puts are bought when a trader expects the asset’s price to decline.

Example of Option Chain

The Nifty 50 option chain gives insights into broader market sentiment, especially when there is a large open interest at specific strikes, signaling a potential resistance or support level.

Conclusion

By delving deeper into these topics, traders can use Option Chain effectively to analyze the options in the market and it helps to identify trends and make well-informed decisions based on the market data.