Let Options Open Interest (OI) guide trading in small range: Shubham Agarwal

We have been trading in a very tight range for a few weeks now. The problem with the range bound market is that the turn arounds are quick and unwarranted. There are 2 issues that are to be dealt with here.

1. Indication to gauge if there is further room for a move in the same direction

2. A Stimulus that can push momentum in a breakout lacking market.

Let us see how Options Open Interest (OI) can help here. OI as we all know is the number of contracts at any point in time in an instrument (Future / Option).

Let us look at a typical OI standing for a particular Expiry Options.

This is from a little while ago in Nifty but still serves the purpose. Few things to note here about Options OI which is true for every symbol + expiry combination.

1. We will usually have more Call OI in higher strikes and more Put OI in lower strikes
2. OI in Options are generally concentrated in few strikes which has a lot of OI in our example look at 24000 Put and 25000 Call.
3. OI unlike volume is equally valid to be seen at any point in time of the day.

However, there is an analogy of Options that will help get the help here to trade better in range bound market.

Options OI is created with the help of both Buyer and Seller. However, we all know Options are like Insurance policies. Here too a buyer will pay premium for some event happening (Call buyer will want the event of a big bullish move). If that does not happen the premium will turn to 0.

Extending this a bit further, Insurance policy cannot exist without Insurance companies. Just like that Options OI has Option Sellers more important counterpart than Buyers.
Since Option Sellers are taking unlimited (better put Unknown) risk to get small premium, they are expected to have better grip on the underlying stock or index’s expected movement.

In short, we can say that more OI means more Option Sellers. History of Insurance companies has it, Option Sellers (Insurance Sellers for Equity) do not lose a lot of money. High OI Call seller to make money stock can not go above that strike. High Put OI seller makes money only if stock does not go below the Put strike.

Let us use this characteristic and find problems with the 2 Issues.

1. High Call OI strike can be a gauge to find the potential room left on the upside. Our example shows small room left up to 25000. But on downside there is room till 24000.
2. Since Option sellers are rarely wrong, when they are proven wrong, it actually turns into a breakout.

In our example of Nifty were to crossover 25000, it could prove the 25000 Call sellers wrong. Them running for cover and fresh buy would make a nice little momentum.

Thus, limited room avoid trade, breakout could get a fresh trade with little under high OI strike as stop loss.