Today, the stock market in India is buzzing with traders and investors. Huge amount of financial instruments change hands daily amounting to billions of rupees. Lion’s share of this huge volume is channelized through the Future and Options (F&O) segment. Increasing interest from retail and institutional traders in options is responsible for it. Traders use technical indicators some of which are the best indicators for options trading.
Options trading is not similar to equity trading. Due to different valuation criteria of options, the trading parameters are also different. The primary difference is that the options have short lives and almost 90% of options become worthless at expiry. So you cannot stay invested in options for long.
The long time investors do not usually show interest in trading options. Options are financial instruments ideally suited for short time trading. Because of complications, options are traded daily and also used as a hedging instrument. Experienced retail traders use best indicators for day trading based on technical analysis. Most of these technical indicators that the options traders use are intraday trading indicators.
There are several technical indicators preferred for intraday trading. Some of the best intraday trading indicators are –
- RSI (Relative Strength Index)
- Bollinger Bands
- MFI (Money Flow Index)
- Intraday Momentum Index
- PCR (Put Call Ratio)
- Open Interest
Before going into the trading part, we must know how to trade options and the risk involved. When a stock goes up, we can buy a Call option of the nearest strike price or we can sell the Put option of the nearest strike price. Similarly, during a downtrend, the trader can sell the Call option or buy the put options of the nearest strike price.
The strike price is the nearest price of the stock future’s current price at which the options are available. Say, if the Nifty is at 16523, the nearest strike price of available options will be 16500 for the Call options and 16550 for the put options. It is best to close the trade in the same day to avoid loss of premium due to time decay.
Time decay is the valuation of premium which is lost with every passing day for which the option exists. Hence, a trader may trade an option by using help from technical indicators. The intraday technical indicators will help the trader to enter the trade and exit as per signal received from the indicators.
There is a huge amount of risk involved in options trading. Unless traded rationally, a trader can easily lose all the capital within a short period. Therefore understanding the correct way of trading the options is quite important.
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Best indicators for intraday trading
There are numerous indicators that can help a trader. This article intends to focus on the best indicators for options trading. Hence we will limit our discussion to a few technical indicators which are suitable for options trading. Traders may use the following indicators or a combination of these as best indicators for intraday trading for trading options.
RSI (Relative Strength Index)
RSI or the Relative Strength Index is a momentum indicator. It indicates the overbought and oversold condition of a stock. This indicator compares current gains to current losses to measure the price momentum. RSI also indicates the oversold and overbought conditions of a stock.
RSI shows a 0-100 scale in which above 80 reading shows the overbought condition and below 20 reading shows the oversold condition. A trader uses these readings and price divergences to enter into an options trade.
RSI is best for options trading in stocks. Trading indices is not advisable using RSI. High-beta stocks are suitable for trading options. The options which are to be traded has to have high liquidity.
The Bollinger Bands is a popular indicator for the options traders. All the options traders know how volatility affects the options price. The Bollinger bands efficiently indicate volatility. When volatility increases, the width of the bands increases dramatically. Contrarily, when there is minimum movement in stock price, the bands contract.
The upper end of the Bollinger bands act as a resistance and the lower end act as a support. Therefore, when the stock price comes near any of the bands, there are high chances of price reversals. If a breakout of support or resistance occurs, the Bollinger bands allow the price to breach the bands and slowly readjusts itself.
An options trader may buy a Put or short a Call in case the upper band is breached. Similarly, if the price breaks down below the lower band, the option trader may buy a Call or short a Put option.
IMI (Intraday Momentum Index)
The IMI or the Intraday Momentum Index is most suitable for high frequency options traders who trade intraday. This indicator is considered as one of the best indicators for options trading. This indicator combines the oversold-overbought condition with intraday trading range.
IMI gives efficient trading signals to an intraday trader. By defining the range, it helps a trader to identify when the price has gone out of range and predict potential reversal points. Also, the trader can initiate contrarian trades at small price reversals using this indicator.
Supertrend is undoubtedly one of the best indicators for options trading. Though Supertrend works like the moving average and MACD, it uses ATR (Average True Range) as its main component. Supertrend has two components. The main component is by default ATR of 10 periods and a multiplier of 3.
Supertrend is one of the best indicators for intraday trading. It works efficiently in intraday trading at 15 minutes chart. Options traders find it suitable as it gives definite buy and sell signals. That is why it is regarded as one of the best indicators for options trading.
Supertrend works best if used with other indicators. Buy signal occurs when Supertrend goes below the price candle. And when Supertrend goes above the price candle, sell signal occurs.
PCR (Put Call Ratio)
The PCR or the Put Call Ratio indicator is a market sentiment indicator. It measures the total Put volume traded versus the total Call volume traded. Instead of taking the absolute value, the change in the existing value of PCR gives better indication of change in market sentiment.
PCR = Total volume of Puts written/ Total volume of Calls written. if PCR>1, then it shows bullishness. And if PCR<1, it shows bearishness. We can also study the historical support and resistance level of PCR values to find the extreme market sentiment at both ends.
OI (Open Interest)
The OI or the open interest is another indicator for trading options. It calculates the total outstanding open contracts at any given time. It indicates the strength of a particular trend. Increasing OI shows increasing strength of trend and declining OI shows weakness. The following table shows how to read OI in different market conditions.
Due to big participation of traders in F&O segment, the OI values change rapidly indicating which way the market is moving. It is necessary to interpret the signals correctly before trading options of a stock.
Trading options is tricky, risky and requires ability to react quickly. It is best to use a trading system using a combination of indicators to get confirmation about the trend before initiating a position. For intraday options trading, buying options prove to be more rewarding. But all the trades must be closed or stopped out before close of the day. Buying options is only suitable for intraday. Option writers keep the trades till expiry to eat premium due to theta decay.
While these are generally regarded best intraday trading indicators for options, it is not uncommon for traders to improvise and develop their own indicators.