Technical Analysis of Options
Technical analysis of options tells the trader what the options market will do next. Analysis of stock and market sector fundamentals will give the trader and investor an accurate picture of the long term prospects of the underlying equity. Investors and traders will often buy the underlying equity based upon future prospects. However, the expected change predicted by market fundamentals may not take place during the term of an options contract. Thus sufficient market movement to make the options purchase or sale profitable may not happen. To implement a long options strategy or short options trading strategy the trader will typically want to rely upon technical analysis of options and their underlying equities.
Indicators for Technical Analysis of Options Price
Price of the underlying equity and the bid and ask prices of the option are the primary technical indicators a trader will watch. When prices are charted they form patterns. Because trading history repeats itself it is possible to reliably predict the next move of a stock based upon its recent and longer term price patterns. Knowing where the stock price is likely to move next is indispensible information for all kinds of options trading. Tracking the price of the option is not as useful as tracking the price of the stock as the option price typically is a direct result of the stock price. However, there are times when market inefficiency due to heavy trading, confusing information, and the like can lead to an option price that is out of line with the value of the underlying stock. That can be an excellent trading opportunity.
Volume is an excellent indicator for the technical analysis of options. Both trading volume for the stock and for the option are useful information. In both cases high volume shows trader interest which typically foreshadows price movement. Coupling volume with price movement is a valuable way to confirm a trend. Some traders believe that price trends are only believable if accompanied by high volume. Whether you are engaging in covered options trading or uncovered options trading you will want to keep track of trading volume when you trade.
Open interest is a technical indicator that is often overlooked. Open interest is the number of contracts on the option that have not been exercised or off set by an opposite contract. Open interest indicates options trading volume as opposed to stock trading volume. High open interest will typically serve to reduce the spread between bid and ask price for the option. More open interest means more trading and more trading means more liquidity. Whether you are trading using a strategy such as a long straddle or a short straddle a more liquid market will make your trading software more accurate in the technical analysis of options.