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Mentoring Batch 4 Day 4
Mentoring Batch 4 Day 4
We hope that you are enjoying the Mentoring program and learning new concepts that help you
become a better trader. During the last 3 days we have primarily been discussing Trading ideas
and data that you need to analyse to catch the Market Sentiment. We have discussed Opening
Trade ideas, Importance of World Markets and VIX and also seen how to prepare a plan for the
expiry session. We will keep revisiting these topics during upcoming days so you can use them
efficiently.
Today we will be discussing the most important link in the chain of Options trading i.e Open
Interest(OI). We have mentioned it earlier also that we consider OI as God for Options trading.
So put in the best of your efforts to learn how to decode the Open Interest. We shall be using
the help of some features of OI Pulse to decode this data.
So let’s begin
Now kindly take note of the highlighted words to grasp the concept to the core
If you are able to understand these two words you can proceed ahead.
Now to begin with there are two kinds of primary Derivatives- Futures and Options.OI
applies to both of them but OI analysis of Options yields relatively more information
about market sentiment. Initially we will try to understand concepts through Futures and
then apply it to Options.
We will oversimplify the real life scenario to understand the concept. Let us consider
BankNifty Futures.
Consider there are only two players in the Market, player A and player B.
Let us say at 9.15 AM at time of opening
Player A feels that Banknifty will go down whereas Player B feels it will go up. So they
enter a contract where Player A sells a contract and Player B buys that contract.
So at 9.15 AM there is only 1 contract present in the Market.
So “total number of outstanding contracts” at 9.15 is 1.
Now consider the situation at 9.20. The beliefs of both players become stronger. So
Player A sells 4 new contracts to player B. The situation would look like this
So at 9.20 AM there are 5 contracts present in the Market. 1 was originally transacted at
9.15 and 4 new contracts were transacted at 9.20
Now suppose the market moved up by 9.30. Player “B” would be in profit. Now he wants to book
some of his profit, for doing so he needs to sell his contracts. He can sell it to the original seller
or a new buyer as per his wish and price offered. Now suppose at 9.30 another player “C”
enters the market who is bullish about Bank Nifty and feels that it will go further up. He needs to
buy a contract in order to enter the market. At this moment it is likely that Seller “A” won't write
new contracts, so he will approach Player “B” the original buyer who wants to sell the contracts
to book some of the profit. A transaction will be done in this case.
It would look something like this
So what happened? One contract (Contract no 4, originally written @9.20) gets transferred to
new Player “C”
OI is the most reliable data that can be used to gauge the Market Sentiment and this is
the reason why it is so important. This data reveals what the majority of market
participants are doing at the moment. If we can align our trade with the dominant
sentiment of the market, it enhances the probability of successful trades. So if you want
to take successful trades confidently then having knowledge of OI is a must.
3. Who determines OI levels buyers or sellers?
It is a very serious aspect that one needs to ponder upon, who determines the Open
Interest buyer or the seller. Well the correct answer to this question is that both Buyers
and sellers together determine the total OI, since it is a contract involving both buyer
as well as seller. So though both determine the total outstanding OI but who out of the
two dominate the pricing of options? The answer to this question is that sellers
dominate the pricing aspect of options for the majority of time and this is the reason
that they dominate most of the time but certainly not every time.
It is an outcome of demand and supply. In derivative options sellers are suppliers
whereas option buyers create demand. There will be times when demand is high and
sometimes supply is higher. When the supply is higher the option prices tend to drop and
when demand is higher the prices tend to rise.
These four terms constitute the heart of this training session and shall be using them
extensively. Thus it is very important that you understand what these terms actually
mean. The following discussion would be a bit technical but very logical. Read this
section twice if you are not able to grasp the concept in one go.
These four terms actually refer to 4 different combinations of “Rise/Fall in Price” and
“Rise/Fall in OI”.
These four combinations can be
1. Rise in Price & Rise in OI
2. Rise in Price & Fall in OI
3. Fall in Price & Rise in OI
4. Fall in Price & Fall in OI
In order to understand them we will go back to our demand and supply graph
Shown above is a simple demand and supply graph, I have used it in the context of Option
contracts. Assume it to be a graph of CALL Option. Along X axis is Quantity of Contracts Open
i.e Open Interest and along Y axis is the Price.
Assume we are at point no 1 where the price is P1 and OI is O1. Now what will happen if there
is a sudden jump in supply of contracts. On the graph we will move from point no 1 to point no
2. Demand Supply equilibrium has been disturbed. Supply has gone to 2. Now in order to
restore the equilibrium demand will follow and the following will happen.
So New Demand curve is generated to accommodate new supply. If we analyse from the graph
what have been the outcomes?
So what happened here , there was an oversupply of Call Option contracts and then buyers got
inclined to them but at a decreasing price.
When will this happen in a Call Option?. Only when the scenario is bearish i.e the Index is
moving or likely to go downwards.
What can we say if we are to analyse this in context of Put options. Put Option writers
would flood the market with new contracts when they are confident that index/underlying is
going to move upwards i.e scenario is Bullish. (A contrast but true).
So we would summarise short build-up in the following manner..
So as an option buyer I know that signals are mixed and should look for opportunities in
the opposite direction and not in their direction. This means if there is a high short built
up in Call option then being an option buyer I should concentrate on Put option.
Strikes with decreasing option prices but rising OI is a honey trap for buyers set by
sellers..STAY AWAY.
In a similar manner I will discuss the other three scenarios. I would use the following figure to
discuss them.
Figure 3: Terminologies
LONG BUILT UP
Refer to figure 3.
Suppose initially the maker is at point no 1 and suddenly there is a jump in demand of contracts
(CALL contracts). The rise in jump happens from point no 1 to point. No 3 along the demand
curve. As a result supply would readjust but at an increasing price which is justified as new
buyers would be ready to pay more price than existing one and sellers would demand higher
price as they are going into a zone of discomfort.
So what has happened here. The buyers have stormed in and broken the equilibrium. They are
enticing sellers to write more contracts by offering them more price. When do you think this
would happen? Only when the index moves in direction of Option buyer i.e In upward direction
for Call buyer and downward direction for a Put Buyer. Thus it may be both bearish or bullish
depending upon which side you want to be.
I would start by saying that Long built up would happen at OTM strike price. It gives a strong
signal that price would move in this particular direction i.e towards OTM strike at which Long
Built up happens. We also have to respect the fact that so many sellers at the strike price with
long build up would provide a strong resistance for the price to cross that level.
As an intraday option buyer I’m only concerned with the rise in option premiums and that can
happen only if index moves in a particular direction and long built up provides that direction. So
in short Option Buyer is confident that
So as an option buyer I should look for opportunities in the direction suggested by Long built up
and not in the opposite direction. This means if there is a high long built up in Call option then
being an option buyer I should concentrate on Call option.
So we see that short built at a strike indicates strongly that price won’t breach that level and
long built at OTM strike gives strong signal the price would move towards that particular strike
but may or may not breach it due to strong resistance offered by Option sellers. What if both
happen simultaneously. It is a strong signal for Option buyers. Consider following hypothetical
scenarios
In order to analyse it further we need to focus on the fact that OI is decreasing. But the big
question is WHY OI is decreasing and who is leading this closure and under what
circumstances. Think in following manner
● If a seller of contract is leading the contract closing/OI reduction then it may be because
of two reasons
○ To book his/her losses and save from further loss
○ To realise the profit
● Similarly If buyer of contract is leading the contract closing/OI reduction then it may be
because of two reasons
○ To book his/her losses and save from further loss
○ To realise the profit
So the conditions for both buyers and sellers are the same, it just happens during different
market conditions.
In fact all these conditions happen simultaneously. Let us try to understand it further.
Now the spot touches 9800. Here sellers start becoming nervous. Some may want to exit as if
the trend continues they would come in a loss making situation. These nervous sellers would
square off their position. However they may be sellers who expect that collective strong
resistance would lead to reversion of trend. So nervous sellers would exit and aggressive sellers
may enter. What nervous sellers would do is to close their contracts and what aggressive sellers
would do is to write new contracts. In this situation the price of option and OI doesn’t change
much.
Now assume price crosses 9800 and touches 9900 and trend establishes. What would happen?
Sellers would just want to exit by squaring off.Their action would create demand and thus further
rise in price of option. So OI would decrease and price would increase as sellers are covering
their position to book their losses.
Now assume the nifty touches 10000 and the trend slows down. Option buyers feel that
momentum is losing and call it a day. They would press the sell button and exit the market to
book their profits. They would have to sell their contacts and thus increase the supply. This
would lead to fall in prices along with fall in OI.
i. Nifty @ 9600: Long Built up @ 9800 CE/Short built up @ 9700 PE: Strong bullish signal
ii. Nifty 9600—->9700: Long Built Up @ 9800 CE continues
iii. Nifty 9700—->9800: Nervous sellers-exiting position/Aggressive sellers -writing new
contracts: OI doesn’t change much
iv. Nifty 9800—->9900: Sellers start panicking: Would square off: OI falls.Short Covering.
Further rise in option premiums.
v. Nifty 9900—->10000: Buyers call it. Day. Book their profits: Would sell their existing
contracts. Oi decreases.Long unwinding.Option premium falls.
This is a hypothetical example..reality would be a bit distorted but things actually shape up in
this manner only.
I would again request you to read this section thoroughly to imbibe the understanding of these
four concepts at a functional level.
Here you can see the strikes falling in different quadrants at any given instant. Unlike the NSE
website you can see the data separately for Nifty and BankNifty.
Lets see what these quadrants are and what do the strikes appearing in them represent
Also if you see CALLs appearing in this quadrant with strength then it points that markets
may witness an upward movement. Similarly if PUTS appear in this quadrant with
strength then it points that markets may witness a downward movement.
So as a buyer of Options always focus on strikes appearing in Q1. If they are appearing
with more than 50 % change in LTP and OI then it is likely that the Premiums of these
strikes may rise further and thus they may be considered for buying provided all the
other connecting dots are also giving the same signal.
Also if you see CALLs appearing in this quadrant with strength then it points that markets
may witness either a downward movement or may just consolidate.. Similarly if PUTS
appear in this quadrant with strength then it points that markets may witness an upward
movement or may just consolidate.
We will be discussing some more practical aspects of OI spurts in coming sessions. The theory
part may bother you a bit initially but pay as much attention as you can as this will be the
foundation of your trading career.
TRADING IDEAS
Now having discussed the theory part let us shift towards the practical aspect of trading. So we
will start with a discussion about the Trading plan for the day.
Opening Trades:
Today is a very special day wherein we should decide not to do any opening trades on
BankNifty because of following factors
It is very important that I again re emphasise that “No Trade is a great Trade” at times.
While Banknifty did not perform on the same front. It did witness an up move but not strong one.
It is still away from the ATH.
It is very important to analyse reasons behind the same. There are two factors behind it
1. Reliance
2. Index Management
Reliance did exceptionally well and since it is the highest index weighted stock it pushed the
Nifty Index up.
On the other hand to keep Nifty 50 from rising too much the Big players used Bank Nifty as a
balancing instrument and kept its rise under check.
In such an environment where we know that BankNifty is being controlled to a great extent it
doesn't make sense to go aggressive on opening.
World Markets
Yesterday it was a holiday in the US and markets were closed on account of Memorial Day. So
the data of US 30 Future will not be relevant for opening trade. INstead we must look at NIKKEI
and Hangseng instead. But till 9.00 AM one was positive while one was negative. So it doesn't
give any clue.
So because of all these factors we will not plan an Opening Trade. We will look for opportunities
on following setups
1. Open High
2. 2 Candle Setup
3. ST/VWAP reversal
But before we do that we must analyse Price action to determine important Support and
Resistance Levels.
On analysing the previous session we find that price after testing a low bounced back and Bulls
took control above 35304. So it will be a major support level for today.
Price remained above VWAP for the entire day and never came towards it. However toward the
end of day price reversed from its high and fell a bit with volumes so that suggests Profit
booking.
So it clearly states that though Bulls are in control at the moment but they are less confident
about taking the Market Higher.
In such a case Yesterday High of 35650 will be a Resistance Level and Bullish zone of 35304
would be a support zone before Yesterday low of 35061.
As per hourly chart 35348 is a support zone and 35670 a resistance zone at the moment.
Supertrend/VWAP Retracement
Now it was clear that Bears had entered the erstwhile Bullish territory so they will make every
attempt to defend their action. In such a situation whenever the price reached back to ST or
VWAP for first time it was a great opportunity to trade
https://www.youtube.com/watch?v=G6CBjgOJUw8
So overall you see that even without Opening Trades we had a lot of opportunities. We decoded
the market and played according to the music of the market.
So kindly go through the theoretical part and prepare for the next trading session on the basis of
Trading plans.
TIll then
Happy Trading!