Why Do Options Traders Need Technical Indicators?
Options are financial contracts that offer rights to buy or sell underlying assets at the agreed prices before the expired dates. The key is to get the correct timing of actions, such as buying, selling, or holding. It is not an easy task as you have to read trading charts to capture the present moves of financial markets. Also, it is essential to take a look at cyclical patterns to accurately forecast the next price movements.
It is time for traders to find powerful technical indicators that generate insightful information. The main purposes are to support spotting hidden signals of opportunities or pitfalls. As a result, you can develop robust strategies to alleviate possible problems.
Time decay is among the important features of options trading. It signifies that you have to decide to buy or sell an option contract before it expires worthlessly. So, the holding period plays a crucial role in the success of a trader, which refers to how long you can hold.
Instead of wandering around the mess of messages, technical indicators can systemize the information in charts and generate good clues for what you should do! Specifically, people use indicators to assist them to identify a range of movements, the next direction of a market move, how long the movement will last, etc.
The next sections highlight some critical indicators that allow you to trade options with much more fun and less anxiety.
Relative Strength Index (RSI)
The Relative Strength Index (RSI) provides the comparison of magnitudes between recent gains and recent losses in a specific period of time. The purpose is to evaluate the asset’s speed and changes in price actions for insights into the overbought and oversold conditions.
The range of values that RSI is from 0 to 100. When it points the value over 70, an overbought level is what it implies. Meanwhile, if it is lower than 30, it shows the oversold levels.
The ideal markets where RSI shows its best include options on individual stocks. On the contrary, the tool does not work well if you choose indexes as the main instruments. The fact that stocks have more overbought and oversold conditions than indexes explains why.
Bollinger Bands
The risk and reward are like two sides of the coin. And volatility is the charming and challenging point of options trading. If you can have it in the palm of your hand, it becomes a strong edge to earn higher profits from your trades. Otherwise, it can waste all your effort, time, and especially money.
It explains why Bollinger bands step up, gain attention first, and popularity now. It is a tool that helps you measure volatility through the expansion or contraction of the bands.
You can also use the Bollinger bands to point out whether prices are in overbought or oversold conditions. If the price moves closer to the upper hand, it tends to be an overbought level. Otherwise, it has more tendencies to be the oversold levels!
Another scenario is that a price movement is outside the bands. If so, you should be ready for reversals with effective positions. For instance, you should start a long put or a short call position after there is a breakout going beyond the top band. On the other hand, if a breakout goes below the lower band, it is advisable to apply a long call or short put strategy.
In addition, you can consider selling options at the peak time of volatility, yet you should buy options when things get slower in price changes. The main point is to sell high but buy low!
Intraday Momentum Index (IMI)
If you are looking for profitable intraday moves, the Intraday Movement Index will be your powerful indicator. It has a mix of concepts between intraday candlesticks and RSI, which you can use to indicate overbought, oversold levels, and the hints for next price actions.
As a result, you activate a bullish or bearish trade at the right time thanks to the insights you get from IMI. You can gain profits or at least protect your earnings no matter how volatile the market becomes.
The result when dividing the sum of uptrend days by the sum of uptrend days and downtrend days is the Intraday Movement Index. Don’t forget to multiply the result by 100! There are many time frames for your selection, 14 days is the most common one.
As mentioned above, IMI shares the structure of RSI so when looking at a number that is bigger than 70, it tends to follow the overbought status. In the meantime, if it is lower than 30, you can consider the oversold conditions.
Money Flow Index (MFI)
Price and volume are two of the most critical factors to make a profitable options trade. The Money Flow Index is a momentum indicator that combines these two data for comprehensive views on trading markets. People also call it volume-weighted RSI to evaluate the inflow and outflow of capital in an asset in a specific time frame which is usually 14 days.
If the MFI shows reading over 80, it means the underlying asset has been overbought. Meanwhile, the implication of reading lower than 20 indicates the oversold conditions.
The Money Flow Index works the best in the context of stock-based options trading and longer-term trades. You can also spot the early signals of a trend change when the MFI moves in the opposite direction to the price of stocks.
Put-Call Ratio (PCR) Indicator
If you want an indicator that concentrates on trading volume, the put-call ratio (PCR) will meet your expectations. Specifically, it indicates the volume of put options vs. call options for you to grasp the present status of overall market sentiment.
The ratio goes beyond 1 when there are more puts than calls, which implies the bearish markets. Otherwise, the signal of a bullish market might take place when the ratio is less than 1.
Open Interest (OI)
Open interest (OI) signifies the unsettled options contracts to show how strong a particular trend is. It can be an uptrend or downtrend, which this indicator does not show in particular.
When the open interest increases, the new capital inflow will happen and strengthen the present trend. Meanwhile, the drop in OI signifies the weakness of a trend.
Before You Go
Of course, there are many other technical indicators that will support your options trading to make it a profitable career. Yet, the indicators that we share in this article are the most basic ones. Hopefully, you can find suitable tools for your needs and smoothen your trades!
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