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Options trading offers flexibility and strategic control to you as an investor while introducing a certain degree of complexity. With price, time, and volatility, beginners often look for tools to decode market behaviour.
Traders use technical indicators like mathematical calculations based on historical price data. They do so to interpret patterns, identify momentum, and confirm market trends.
Options trading involves buying and selling contracts that give you the right to buy or sell an asset at a price before a certain date. It is a flexible tool used for boosting investment income.
It is a contract that gives you the right, but not the obligation, to buy or sell an underlying asset. This is done at a pre-defined price (strike price) before a specified expiration date.
There are two main types of option contracts:
Call Options: The right to buy the asset
Put Options: The right to sell the asset
Options are cash-settled in India and traded on exchanges like the National Stock Exchange (NSE). Unlike shares, options have multiple moving parts, including time value and volatility. This makes pricing and analysis more layered.
Each of the following indicators has specific strengths. When used correctly, they can support trade planning, signal confirmation, or alert you to possible shifts in trend.
What it is: A momentum oscillator that measures the speed and magnitude of recent price changes
Calculation Formula:
RSI = 100 – [100 / (1 + Average of upward price change / Average of downward price change)]
How it helps:
RSI values range from 0 to 100
Readings above 70 may indicate overbought conditions
Readings below 30 may indicate oversold conditions
For options traders, RSI can help time the entry of short-term positions. It is helpful, particularly for range-bound strategies, like iron condors or credit spreads.
What it is: A short and long-term trend-following indicator that smoothens price data
Types:
Simple Moving Average (SMA): Average of closing prices over a specific period
Exponential Moving Average (EMA): Similar to SMA but gives more weight to recent prices
Formula for SMA and EMA:
SMA = (A1+A2+…+An) / n
EMA = [Closing Price of the Stock x the Multiplier] + [Previous Day EMA x (1- the Multiplier)]
How it helps:
50-day and 200-day SMAs are common for spotting longer trends
Crossovers (e.g., 20-EMA crossing above 50-EMA) are often used as trend confirmation signals as to indicate buying and selling opportunities
Moving averages also serve as support/resistance levels in many strategies
What it is: A volatility-based indicator formed by three lines:
A 20-day middle band indicating Simple Moving Average (SMA)
An upper band = SMA + 2 standard deviations from SMA
A lower band = SMA – 2 standard deviations from SMA
How it helps:
Wider bands reflect high volatility, and larger price swings
Price touching the upper band may indicate overextension
Used for breakout strategies or short volatility setups
In options trading, Bollinger Bands help assess the likelihood of the price staying within a defined range. They are useful for range-based spreads.
What it is: A momentum indicator that shows the relationship between two moving averages (typically 12-day and 26-day).
Formula:
MACD = 12-day EMA – 26-day EMA
Signal Line = 9-day EMA of the MACD line
How it helps:
Crossovers between the MACD line and the signal line may indicate momentum changes. An upward momentum is indicated when the MACD line crosses the signal line. A downward momentum depicts a bullish crossover when the MACD line crosses below the signal line.
Used to identify divergences between price and trend strength
The MACD is useful when planning directional options strategies, such as long calls or puts, based on trend alignment.
What it is: A market-based metric indicating expected future volatility of the underlying asset. It is not directly observed but derived from option prices.
How it helps:
Higher IV = Interprets market expectations for a security price to fluctuate more in the future
Lower IV = The market expects the security price to become more stable in the future
IV is a critical element of options pricing. Strategies like straddles and strangles are directly influenced by IV forecasts.
What it is: The total number of outstanding contracts in the current market due to pending settlement or delivery.
How it helps:
High OI at certain strikes = potential support/resistance levels
Resistance at strike price = High OI build-up for call option
Support for a price = High OI build-up for put option
Open Interest is especially helpful in intraday and expiry-based strategies.
What it is: A ratio that compares the volume or open interest of put options to call options
Formula:
PCR = Put Volume / Call Volume
How it helps:
PCR > 1: Bearish sentiment
PCR < 1: Bullish sentiment
PCR ≈ 1: Neutral sentiment
PCR is a sentiment tool, often used as a supplementary indicator with price-based tools.
Combines elements of RSI and candlestick analysis to identify overbought or oversold conditions within a single trading day.
Uses price and volume data to assess the strength of money flowing in and out of a stock, helping spot trend reversals.
Unlike stock traders, you, as an options trader, need to check time decay (theta), implied volatility (IV), and liquidity. These indicators help identify:
Momentum and trend reversals
Breakout or consolidation zones
Volatility levels that influence option premiums
Sentiment in the form of open interest and put-call ratios
Relying on one indicator may provide an incomplete view. Many traders combine tools for stronger signals.
Examples:
RSI + Bollinger Bands: Can help find overbought/oversold conditions
PCR + OI: Validates market sentiment
Indicators can be valuable tools, but many traders may misuse them or rely on them too much. Avoiding common mistakes, such as using complex combinations, can improve your strategy.
Mistake |
Why It Matters |
|---|---|
Relying on a single indicator |
Doesn’t reflect all market dynamics |
Ignoring risk management |
A small mistake, like ignoring stop-losses, can lead to big losses |
Using complex combinations too soon |
Complicates decision-making without clarity |
Indicators are valuable tools that support informed decision-making in options trading. While they do not predict the market, they help you read underlying signals, build strategies, and manage risk. For beginners, mastering a few simple indicators can foster confidence and consistency.
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
There is no single one-size-fits-all tool. While beginners may find RSI and moving averages easiest to start with, combining different indicators is best to make more informed decisions.
They serve different purposes, and the better indicator depends on individual preferences. IV reflects option pricing and expected movement, while RSI measures price momentum.
For expiry-based trading, you can try to combine different indicators for a more detailed market analysis.
Yes, although parameters (such as period settings) may vary. Intraday trades often use shorter look-back periods.
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Posted on 18 Aug
Geetanjali Lachke
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