Options trading allows investors to buy and sell call (or put) options, which derive their value from the underlying assets such as stocks, bonds, commodities, etc. While options trading looks challenging at first sight, there are several option trading indicators that can directly help you pinpoint the buy and sell signals. This blog will cover the six best indicator for option trading and how you can use them to make your trading seamless.
6 Best Indicators For Option Trading In India
The option trading indicators help you to evaluate the price movements and give you a sign to take buy or sell positions. As options are bound to expire, it is important to make the right decisions at the right time. Here is the list of the six best indicator for option trading for a well-planned execution:
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1. Moving Averages
The simplest and best indicator for option trading is the moving averages, which help in identifying the price trend of the stock (or underlying of option contracts). When the stock is trading above its moving average, it gives a bullish signal and vice versa. There are two types of moving averages that you can use – Simple Moving Average (SMA) and Exponential Moving Average (EMA).
The SMA calculates the average share price of a stock over a period of time, days or months. The EMA also considers the past price movements but gives more weightage to the latest prices. If a stock suddenly spikes, the EMA will show this change faster, helping traders react quickly.
When the stock’s short-term (7-days) SMA crosses above the long-term (30-days) SMA, it is a bullish trend, and you can buy call options. When the short-term (7-days) SMA crosses below the long-term (30-days) SMA, it is a bearish trend to buy put options. This best indicator for option trading can directly help you take positions in options based on the MA signal of the underlying stock.
2. Bollinger Bands
Bolling Bands, a best indicator for option trading, is a measure of volatility. In times of high volatility, it is good to sell options as the prices can turn overvalued. In Bollinger Bands, there are three lines – the middle, upper, and lower bands.
The middle band showcases a simple moving average (SMA) of the stock price over a specified period. The upper band is the SMA plus a standard deviation of the stock prices, and the lower band is the SMA minus the standard deviation of the prices.
If the price of the stock hits or crosses the upper band, it signals that the stock is overbought. In this case, you can consider taking a long put or short call position. On the other hand, if the price of the stock touches the lower band, it signals that the stock is oversold. In this case, a long call or short put position can be considered.
3. Relative Strength Index
The Relative Strength Index (RSI), a momentum option trading indicator, helps you analyze overbought or oversold conditions by measuring the speed and change of stock price movements. The value of RSI falls between 0 and 100, and it measures the speed and change in price movements to analyze overbought (or oversold) situations.
An RSI above 70 signals an overbought situation and possible price reversal, correction, or bearish nature. An RSI below 30 signals an oversold situation and possible upward movement or bullish nature.
An RSI above 70 provides an opportunity to buy put options, and an RSI below 30 signals buying call options. By accurate analysis of the price movements of the underlying stocks through this best indicator for option trading, you can benefit from trend reversals and lock in profits.
4. Intraday Momentum Index (IMI)
Intraday Momentum Index (IMI) is the best indicator for option trading for intraday purposes. The indicator combines the RSI and candlesticks to provide a picture of how the stock can move before the market’s closing hours.
The reading of the indicator is similar to RSI, with a value below 30 indicating an oversold situation and an ideal opportunity for buying call options and selling put options.
While a value above 70 indicates an overbought condition and an opportunity to buy put options and sell call options. This indicator is tailor-made to analyse short-term price movements and intraday options trades.
5. Open Interest
Open Interest (OI) is the total number of open options contracts in the market and signals market strength and liquidity. When OI rises for a particular contract, it indicates that the money is coming in, and the current price trend can continue. When OI falls, it indicates that the money is going out, and the current price trend may reverse.
With rising OI and an upward trend in stock price, you can buy call options. With falling OI and a downward trend in stock price, you can buy put options. This is the best indicator for option trading to take the contrarian approach when the OI reaches extreme levels.
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6. PCR Indicator
The last best indicator for option trading is the put-call ratio (PCR), which compares the volumes of the call and put options. This indicator compares the trading volume (or OI) of put options with the trading volume of call options. Rather than considering a static value of the put-call ratio, a change in its value clearly signals the overall sentiment of the market, and you can pick the right price movements.
The PCR ratio will be higher than 1 when there are more put options being bought than call options by the traders. It is a bearish sentiment, and you can buy put options or sell call options to capitalize on the current opportunities.
When the call options volume is greater than the put counterparts, the ratio is less than 1. It is a bullish sentiment, making an ideal opportunity to buy call options or sell put options. If the PCR ratio is near 1, then the market is neutral, and you can use the straddles and strangles strategies.
Conclusion
The best indicator for option trading helps you to take buy or sell actions based on the current trend and also minimizes the possibility of high losses. They will help you capitalize on market opportunities and take corrective steps as well. If you want to deploy these option trading indicators to trade like a pro, then open free Demat Account with SMC Global Securities now.
Frequently Asked Questions – FAQs
1. Which indicator is more effective for option trading?
The effective and best indicator for option trading is the Relative Strength Index (RSI). This momentum indicator will help in analyzing the speed and change in price movements of the underlying asset. Through direct indication of overbought or oversold conditions, the traders can take the right entry and exit strategies.
2. What is the most successful trading indicator?
The most successful option trading indicator can be the combination of different types of indicators to analyse price trends, volatility, momentum, and volume. This holistic approach will help you confirm your strategy and make the correct decisions in buying and selling.
3. What is the trick for option trading?
The best trick for option trading is not to stick to any one strategy or indicator. It is crucial to understand current market volatility and price movements of an underlying asset and then deploy different strategies such as covered call, iron condor, etc.
4. Which technique is best for option trading?
The best technique for option trading is to identify the current price trends with Moving Averages. Second, use the momentum indicator such as RSI to gauge the speed and strength of the price trend. Third, analyze the volatility as it can help you understand how large the price swings can happen. Lastly, spot the right entry and exit points as per the underlying stock price trend, momentum, and volatility.
Author: All Content is verified by SMC Global Securities.
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- 20 Lac+ unique clients
- 33+ Years of Serving
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- Free Demat Account
