For a beginner in Options trading, knowing option chain and analysing the data is very useful. Option chain gives you all the specific data you need while trading in options. Learning how to read an option chain is a vital part to options trading. Many traders lose money in options trading because they don't fully understand option chains.
Once you understand the option chain, your option trading stratergy and money making skills in share market will certainly improve. Understanding option chain gives you a clear idea about choosing best strike prices like, In the Money (ITM), At the Money(ATM), Out of the Money(OTM). Know more about Option Moneyness here. Let us now begin to understand the basics of Option Chain Analysis.
What is Option Chain?
Option chain is a list or table of all available option contracts. It includes stocks and index with put option and call option, for a given security. The table includes information on Open Interest, volume, Implied Volatility(IV), strike price, premium etc. of a option contract for a given exipration date. Remember, just as there is an option chain for the Nifty, banknifty & other, you have option chains for all the key indices traded in F&O and also for individual stocks where options trading is permitted. However option chain is relevant only when the contract is sufficiently liquid.
Basics of Option Trading In India:
Before we begin to understand all the terms present in option chain table, let us know basic of option trading and about Moneyness of an option contract.
There are two types of options – The Call option and the Put option. You can be a buyer or seller of these options.
Basic of Call Option:
“The buyer of the call option has the right, but not the obligation to buy an agreed quantity of a particular commodity or financial instrument (underlying) from the seller of the option at a certain time (expiration date) for a certain price (strike price). The seller (or writer) is obligated to sell the commodity or financial instrument should the buyer so decide. The buyer pays a fee (known as premium) for this right”.
Basic of Put Option:
On the other hand, Put Option is a contract that gives you the right but not the obligation to sell the underlying at a specified price and within the expiration date of the Option. Here again, the contract gives you the right but it is not mandatory for you to sell the underlying.
In other words If you’re buying a call option, it means you want the stock (or other security) to go up in price so that you can make a profit from your contract by exercising your right to buy those stocks (so that you can sell them to cash in on the profit). Opposite to this is put option perspective, he wants the price to decline to benefit. when you buy options you can either hold the option till expiry and let the exchange do the settlement for you this is called Exercising a contract or you can close the position before expiry and book profits/loss.
Moneyness of an option contract:
Moneyness in options can be define as the association between the strike price of an options contract and the price of the underlying security.The underlying price is the price at which the underlying asset trades in the spot market.This is current market price at which stock is trading in spot market .
There are three main classification that are used to describe the moneyness of an options contract.
In the money (ITM) - A call option is in ITM if its strike price is less than the current market price of the underlying asset. A put option is ITM if its strike price is greater than the current market price of the underlying asset.
At the money (ATM) - When the strike price of a Call or Put option is equal to the current market price of the underlying asset then it is in ATM.
Out of the money (OTM) - A call option is OTM if the strike price is greater than the current market price of the underlying asset. A put option is OTM if the strike price is less than the current market price of the underlying asset.
You might be thinking What is the purpose to know all this terms. As a matter of fact Even if you are just using very simple strategies like taking a single position, you still need to consider moneyness. Understand this every options trading strategy requires knowing what moneyness state the options you are buying or selling (writing).
For example, if you are buying contracts on an underlying security that you expect to move substanialy in price in a short time frame, then buying out of the money contracts would increase chances of your profits. On the contrary If you are expecting a smaller movement, then in the money contracts would probably works as a better &less risky .
In case you start using more complex strategies, moneyness becomes even more important. Another example,May be a strategy might involve buying in the money contracts and then writing out of the money contracts on the same underlying security.