Monetise options beyond options trading

Options are very agile instruments with their non-linear pay-offs and favourable risk profiles (at least for the buyers). While it is important to trade them using single Options (Buy or Sell ) or various combination of them, it is also important to realise a unique utility of the Options and that is analysing the trade data.

As we all know that Options being financial derivatives are traded with a perspective on the underlying asset. While the available instruments (Option types, Expiries, Strike Prices) remain more or less standard, the level of activity and the intensity of trading (Price) keep changing. The variations into these trade data points give away a lot in terms of overall market consensus. This data analytics opens a whole new window of trade improvisation.

Trade data analytics being a vast subject in itself, we may not be able to discuss all of it but let us pick three of the most important ones along with their utilities.

1. OIPCR (Open Interest Put Call Ratio):

Open Interest is the number of contracts outstanding in any particular instrument (like, any strike call/ put on any stock/index of a particular expiry)

OIPCR = Total Open interest of All the Puts*

Total Open Interest of All the Calls*

* of a particular underlying

First, Let us understand the intention that initiates the action of buying or selling options.

1. Buy Call when Bullish
2. Buy Put when Bearish
3. Sell (Write) Call when Neutral to Bearish
4. Sell (Write) Put when Neutral to Bullish

It is believed Option are like insurance and the providers of Insurance a.k.a. Option Writers know more about underlying asset (in insurance example our life expectancy).

Now if we have more Open Interest in Calls that means we have more Call writers than Put writers that means majority of writers (the wise ones) hold the expectation of neutral to bearish underlying while more put writers indicate otherwise. The same argument holds otherwise for more Put writers, indicating majority with neutral to bullish view.

So, if OIPCR is more than one, it is bullish. If it is less than one, it is bearish. However, the major utility that we have found out of this indicator is much more than this. The reading of OIPCR is available on many platforms on the web.

Observing Index OIPCR on a regular basis pays-off as OIPCR is also mean reverting in nature. Too High OIPCR does not sustain for long and not too low OIPCR. Secondly, OIPCR is directly correlated with the market (Falling Market will have lower OIPCR because the Put Writers would be missing).

Utility of OIPCR analytics: Keep a close watch if we see the index at a recent high (a few weeks at least) coinciding with recent High in OIPCR. It means there could be a reversal in offing. Turn to very risk averse mode and tighten your stop loss, create hedge.

Alternatively, if the OIPCR and the index are at recent low, do the other way around. Reduce shorts, start bottom fishing on minimalistic level as the tide could just turn, if not permanently may be temporarily.

#2 Implied Volatility

This fancy element in plain English is the expensiveness of the option. It results in the inflation in premium just because the expected volatility is high just like ahead of an event and deflation just because an event has passed by and calmer times are expected ahead.

As the four factors used in calculation of option premium viz. Underlying Price, Strike Price, Time to Expiry & Risk-Free Rate of Interest do not have any different answer, given these four known factors and the premium traded in the market. The volatility figure back-calculated is called Implied Volatility.

Any significant change in the premium without any significant change in underlying price and time to expiry can now be attributed to changes in Implied Volatility. Higher premiums are attributed to higher implied volatility and lower premiums are attributed to lower implied volatility.

Calculating Implied Volatility is difficult, but most of the markets now have an Index of Implied Volatility of Index Options like we have India VIX for Nifty, which can be used as a proxy. Like OIPCR, Implied Volatility is also mean reverting in nature but is inversely correlated to the underlying.

Utility of Implied Volatility Analytics: More often than not the Underlying tops and Implied Volatility Bottom coincide. So similar to OIPCR if we see Implied Volatility at recent high while index has been falling to fresh lows, there could be a breather in place and so is true for other way around also, when Implied Volatility I at recent low.

This one is the easiest. Carrying forward a few thoughts, as we learnt the Open Interest figure is readily available. Look for the heaviest Call Open Interest in the entire set of strikes. One would find Heaviest Call strike higher than current market price and heaviest Put strike lower than the current market price.

1. Look at those strikes and one would get an idea what is the ballpark range expected by the market consensus for the underlying to trade into the expiry those options belong to.
2. In case if the stock moves above any one of these strikes, there would be a break in consensus and could trigger a serious move so If a call strike is surpassed there could be a sharp up move and other way around for Put.

There we have it, these are just the tips of big icebergs mentioned above. There is a lot more to it. I would sincerely recommend reading into these along with your existing trade finding techniques and benefit from it.