Options Trading is Different because you are trading Derivatives. Derivatives are defined by their Underlying Assets, so you have to constantly keep an eye on the Underlying Assets and their Options. And there are many other things you need to watch simultaneously including the Theta, Gamma, Delta, PCR, Open Interest, and so on.

It’s a kind of Confusion and you also have to be super active to enter and Exit the Trade because a small price movement in the wrong direction of the Underlying Asset is enough to wipe out your 10 – 20% of capital.

So, Traders use Indicators to measure the technicals of those Options and to utilize the information available. The Strategies used by Traders can be different based on their Trading Style and Preferences. Some use indicators for Finding buying Signals, Some of them for placing perfect Stop-Loss, Some of them for Finding The Trend, and So on.

So, in this article, I am going to focus only on some of the most popular Indicators for Options Trading among Traders and yeah it’s my favorite Indicators, So I am decoding the strategies behind these indicators based on my personal experience.

Let’s Start,

7 Best Indicators for Options Trading

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1. RSI – Relative Strength Index

RSI- Relative Strength Index, is a momentum indicator used for measuring the Recent Gains and Losses of security in a specific period, to identify the Overbought and Oversold conditions in the price of that particular security.

It is a momentum Oscillator used in Technical Analysis, to measure the Velocity and Magnitude of price movements. Basically, RSI indicates security overbought and Oversold Zones to identify the right entry and exit point, and sometimes Trend Reversal.

It ranges from 0 to 100, where Above 70 is considered an Overbought Zone (indicates Sell Signal), and Below 30 indicates an Oversold Zone (indicates Buy Signal).

Developed by J.Welles Wilder, RSI is a Leading Indicator and one of the most popular Indicators for Options Trading. Not only this RSI is one of the few indicators that give you almost accurate data about a Stock.

And, the best part is RSI works great with Individual Stocks as compared to Index, as the stock moves through overbought and Oversold zones more frequently than Indices like Nifty 50 and Bank Nifty.

2. EMA – Exponential Moving Average

It’s not the Simple Moving Average, it’s the Exponential Moving Average, which obviously is a type of Moving Average but instead of giving a broader view like Moving Averages, it reacts more quickly to the recent prices.

Look at the Chart Below,

As you can see in the Chart, where a 30-period EMA (in the Blue Line) and a 30-period SMA (in the White Line) are plotted on the Nifty 50 Chart, as the EMA tends to react more frequently and put more weightage to the recent price movements, where the Simple Moving Average is less reactive and also delayed when plotted on 15-min time frame.

And as you know, in trading every candle matters, as one wrong decision will wipe out your 10-20% of the capital. Hence, most trader prefers to choose Exponential Moving Averages, over Simple and Weighted moving averages, as it puts more significance on the recent data points, and EMA works well in Intraday Trading.

So, how do you trade using EMA’s

Well, I don’t advise you to take my word, instead do your research, Back-Test some methods, and then reach any result.

So, for placing the EMA, there are two main things to determine, First – which type of trading do you prefer (eg. Scalping, Swing Trading, because EMA acts to recent prices, I am assuming you are in search of Short term trends.), and How often you follow your Rules (eg. Exiting on Stoploss and Targets). Just Ask these with Yourself.

So, there are 2 most popular EMA practices traders follow, first 9-period and 15-period EMA (for Scalping), and 12-period and 26-period EMA for Swing Trading.

Once you place the EMA wait for candle rejection, when the Candle rejects the shorter period EMA makes a healthy Red or Green Candle, after then the next two or three candles stay at the top or at the near-top of that healthy candle, and then the next candle starts moving with volume in the direction of that big-healthy candle, then you can trade in that direction.

It’s not as simple as I describe in the words, there are many more things to look at at the same time, like other Indices, India Vix, Options Premium, RSI, MACD, and so on.

3. Bollinger Bands

Probably one of the most important Indicators for Options Trading, and why not because it tells you how volatile the Market is.

So, I am assuming you are aware of the volatility, because in options Trading Volatility is a key factor for fast price movement, hence Bollinger Band comes into play as it defines the market Volatility.

Basically, when you plot Bollinger Band on the chart, it shows you three lines, consisting of a 20-day Simple Moving Average (the middle line), an Upper Band (+2 Standard Deviation of the SMA), and a Lower band (-2 Standard Deviation of the SMA), giving you an overview of the market Volatility and the Overbought and Oversold Zones of a particular Security, as the band Contracts when the market is less Volatile, and the band Expands when the market is more volatile.

So,

How do you Trade With Bollinger Bands?

The Most Common Approach for Trading using Bollinger Bands is to identify Overbought and Oversold Zones, hence you as a Trader can use Bollinger Bands to buy when the Market is Oversold, and Sell when the Market is Overbought.

So, how do you Identify this?

First, in a Range market, – Bollinger Band works well in range-bound markets as the Market is traveling between these two bonds so frequently, and you can initiate the Trade in the Opposite Direction Price in which the Price moves out of the Band, as the Market is set for Reversal, because of high Supply from that price point.

Second, In a Trending Market – Look at the Trend, and Always Remember that “Don’t Trade against the Trend”. So take the example of a DownTrend, Plot the Bollinger Bank on the chart, then wait for Volatility, once volatility increases then look for the price to Move out of the Band in the Direction of the Trend, then wait for a Pullback as the Market is Oversold Now, and once Upperband is tagged, now you can take Short Position, and exit when again the Lower Band is Tagged.

4. OI (Open Interest)

Open Interest is basically the Number of Open Derivative Contracts of a particular security in the market, either it will be Futures or Options which has not been settled yet.

Here is a Chart of Open Interest of ICICI Bank of Feb 2024 Expiry.

In the Image Above, You can see that there are lots of Calls compared to Puts which means, the price of that particular security may not go up(there might be fluctuations as volatility increases).

But You need to know that Open Interests are just a number showcasing how many Buyers and sellers are interested at any price point of that particular security.

So for instance, If Person “A” buys a Call Option and Person “B” sells a Call Option then there will be 1 contract that is currently opened. But These numbers don’t really tell you the Trend of the Market, so don’t be fooled, These contracts act as a Buyer and Seller Zone.

How Do You Trade Using Open Interest?

Note:- OI is viewed from the perspective of Sellers, the more the OI on a side, the more the sellers are.

There’s no way that you can simply view OI and get a clear-cut picture of the Market, so how OI help you in Options Trading?

Here’s the Perception a Trader can Build by watching OI.

1. If the OI on the Put Side and the Price is also Rising, means the Security is Strong.
2. If OI on the Call Side is Rising and the Price is Falling, means the Security is Weak.
3. If OI on the Put Side is Rising but the Price is Falling, Then There may be a Reversal.
4. If OI on the Call Side is Rising but the Price is Rising, Then there may be a Reversal.
5. If OI is Declining and the Price is Rising, means the Security is weakening.
6. If OI is Falling and Price is also Falling, it Means Security is strengthening.

5. PCR – Put Call Ratio

PCR is directly related to Open Interest and it is a Ratio of Total Puts and Total Calls, and here you can get the PCR value by Dividing the Total Number of Put Interests by Total Number of Call Interests.

So let’s Analyze the PCR,

Assume There are 1000 Put Open Interests and 1400 Call Open Interests then we first Divide Put by Call – 1000/1400 = 0.71, which is the Actual PCR, and this is what a (0.7) is considered a good PCR and an average parameter for gauging Market Sentiments.

Now, We know what PCR is and how it’s calculated, let Understand what’s PCR indicates.

As I mentioned above the PCR doesn’t tell us any direction of the market but can tell us what the Sellers are doing.

First start by observing the Puts and Calls, if there are more Puts Open Interests than Call OI then the Market may go up as sellers are Bullish, and when there are more Call OI than Put OI then it means that the Market may go down, as sellers are Bearish – and this is what PCR tells us.

Here is a subsequent range of PCR,

• If the PCR of Open Interests is 1.0 or closer to 1.0 then the Market may remain sideways. (PCR is 1.0 or closer to 1.0 = Neutral)
• If the PCR is above 1.0 or slowly rising to 1.5, then the Market may be Bullish, (PCR is 1.0 – 1.5 – 1.6 = Bullish)
• But, if the PCR is above 1.5, then it’s in the Overbought Zone, and we can see a Reversal anytime. (PCR is > 1.5 = Extremely Bullish, and Ready for Reversal)
• Now, If the PCR is less than 1.0 and slowly decreasing to 0.6 or 0.5 then the Market may be Bearish, as Buyers are interested in Calls. (PCR is 1.0 – 0.5 = Bearish)
• But if the PCR is less than 0.5, then it’s in the Oversold Zone and we can see a Reversal anytime. (PCR is < 0.5 =Extermely Bearish, and Ready for Reversal)

6. MACD – Moving Average Convergence Divergence.

MACD is a Trend-based Momentum Indicator used by many traders to generate Buy and Sell Signals. It is so simple and flexible that one can easily understand its mechanism, and becomes one of the most popular Technical Indicators for Trading.

MACD consists of Three Things,

First – A MACD Line which is the combination of the 26-period and the 12-period Exponential Moving Averages (EMAs) to determine the Bullish or Bearish Signals.

Second – A 9-period EMA Line which is self-plotted when you plot MACD on the chart, which is called the Signal Line, that acts as a trigger point for Buying and Selling when MACD crosses over it.

Third – A Histogram, which is basically a graph or you can say a visual representation of the difference between the MACD and the 9-period EMA, that is shown on the chart with a line in between known as the Zero Line.

Now you know what the MACD is, why it’s important in Options Trading,

So for Now, let’s Learn

How to Trade Using MACD

There are so many strategies Traders use to Trade using MACD like Histogram Strategy – To identify the Momentum, CrossOver Strategy – To Identify Bullish and Bearish Signals, Zero-Cross Strategy – To find Buy and Sell Signals, Money Flow Index – To identify the Overbought and the Oversold Zones, and so more.

But for now, we are using the CrossOver strategy, which is the best and most preferred way. You can Learn Other MACD Trading Strategies here.

As in Crossover Strategy you look for a Crossover, where the MACD Line crosses the 9 EMA line. So, when the MACD crosses the 9-Day EMA from the Bottom then it’s indicating a Bullish Sign, and when the MACD line crosses the 9EMA line from Top then it’s indicating a Bearish Sign.

7. VWAP – Volume Weighted Average Price

VWAP or Volume Weighted Average Price is a metric used by Traders and Investors to determine the Average Price of a particular security over a particular Time frame weighted by Volume.

VWAP helps Investors and Traders determine the Average Price of a particular stock to identify if the security is Overbought or Oversold with respect to the Average Trading Price of the Day. Basically, VWAP acts as a fair Price Value of a Security where both Buyers and Sellers Agree to Buy or Sell the Security on a particular Day.

This is also used by Institutions and Other Big Players, for example, if you wanna buy 10,000 shares of a particular company, then how do you determine whether the current price is Overvalued or Undervalued, and here VWAP comes into Play This helps Investors to buy below or at the Fair Price Value.

How do You Trade Using VWAP

Note – You can Only Add VWAP where there is any Volume, for eg. Any Stock, Options, Futures, but you can’t Plot VWAP on an Index Chart like Nifty and Bank Nifty

VWAP is generally used to get buy and sell signals, and VWAP works well in a Sideways Market on an Intraday Time frame, as the Market is Trading in a Range from its support to resistance levels and Traders usually go Long when the price of that particular stock is trading below the VWAP because the Benchmark (VWAP) beating the buyers, and Go Short when the price of that particular stock is trading above the VWAP.

For More VWAP Trading strategies you can Read this Article.

Important Things to remember when you are in Options Trading.

1. Never Trade Against the Trend (if you are going against the Trend, you need to be super fast, and ready to exit at any time because of the strong market)
2. Do not Trade Out of the Money options.
3. Always Set a Stoploss and most importantly Set a Target.
4. Don’t Put more than 25% of your Total Capital in a Single Trade.
5. Do not Trade Options Emotionally, as you need to bear heavy losses.
6. Keep an Eye on the Futures Contract of which you are trading Options.
7. Don’t Just Rely heavily on One Indicator (Generate Multiple Signs before initiating the Trade).

Happy Trading,