How you can increase chances of making profitable trades by analysing F&O data

Sunil V Tinani

The stock market is a 2-in-1 market. You have the cash (spot) market and then there’s the derivatives (F&O) market. Both go hand in hand.

Traders typically forecast movement in a stock based on the cash charts. However, many traders miss out analyzing the F&O data that make up over 50 percent of the market. Surprised?

Here is an example of how a cash chart can mislead:

A strong hand sells 5,00,000 shares of ‘X’ stock in the spot market. The charts are filled with blood red candles and indicators dive into negative territory.

Screeners pick up the signals and alert traders of the fall.

Traders short the stock and as they are shorting, the strong hand swings into action and starts buying X stock in the F&O (Futures & Options) market.

They vacuum 25 lakh shares at a reduced price by paying the same price that they would have paid for buying about 6 lakh shares in the cash market (25 percent margin).

Soon, the price stabilizes and inches up a couple of notches because traders want to cover.

The strong hand then starts buying in the spot market. And, then the short covering begins. Red turns to green and there’s mayhem on the charts.

Well, this is a hypothetical scenario with the point being that it pays to go beyond the charts and analyze F&O data before entering into a trade. A heck lot of action happens in the F&O market and if you are not analyzing it, you are playing blind.

The next question is how should one analyze F&O data?

The F&O, or derivatives, market is made of futures and options. The futures prices can be analyzed by reading the Open Interest (OI) data and the options by analyzing the options chain data.

Here is how you do that:

Part 1: Open Interest

What is Open Interest (OI)?

OI is easy to understand. Here is an example that’ll help you grasp the concept:

One RIL futures lot contains 500 shares. Assume there are just 2 participants in the market - A and B.

A buys one lot and B sells one lot and both take the position home. Now, A is long 500 shares and B is short 500 shares. The outstanding position per participant is 500 shares.

Therefore, OI for the day in RIL is 500.

Exchanges calculate the open outstanding positions on one side (buy or sell) and post the data as OI.

How to interpret Open Interest?

(i) OI Positive - Price Rises - Volume Rises - BULLISH

Outstanding positions are rising which means traders are taking positions home. They are confident that the price will rise. If volumes move up in this scenario, it means bulls are chasing the stock.

(ii) OI Positive - Price Falls - Volume Rises - BEARISH

Outstanding positions are rising which means traders are taking positions home. They are confident that the price will fall and are shorting the stock. If volumes move up in this scenario, it means bears are hammering the stock.

(iii) OI Negative - Volume Rises - BULLISH or BEARISH

If you see volume rising and OI falling, you must immediately check the daily charts and check the movement of the stock in the past few days.

If the stock price has been rising in the past few days, and if OI is falling, it could be that bulls have started liquidating longs.

If the stock price has been falling in the past few days, and if OI is falling, it could be that bears have started covering shorts.

Therefore when OI turns negative, you should always consult the daily charts and view the price to check the movement of the past few days.

As an example, here is RIL’s daily chart and you can see that the stock keeps going into forward and reverse gears every few days.

Source: Investing.com

Check the daily chart of any F&O stock. You will see that after a few days of rise or fall, there is a reversal. Therefore it makes infinite sense for any chartist to check the F&O data before arriving at any conclusion.

Where to get Open Interest data?

Below is an excellent resource. It is delayed by 5 minutes or so, but it delivers data per sector. Know that even the top F&O data tools are delayed by 2-3 minutes.

Moneycontrol sector wise Open Interest & Volume

Part 2: Options chain

What is options chain?

The options market is dominated by writers (option sellers), which include DIIs, FIIs, proprietary desks of all brokerages and options writers. And of course, us - the suckers who end up burning cash.

Options is a big business and you should learn how to see through what the big players are up to.

Now, you already know the options market is made up of CEs (Call options) and PEs (Put options).

You also know what OI is, and you also know what change in open interest is. Now here is how you interpret options chain data.

How to Interpret Options Chain?

Focus on the “Change in OI” column and apply the following logic:

CALLS (CEs)

Positive change in OI implies writers are selling the CE and this is because they feel the stock will not rise to the respective strike price. You also should note down the price where the highest change in OI is happening and treat it as a resistance level.

Negative change in OI implies writers are covering their shorted CEs because they feel the stock will rise. If the change in OI, in this case, is heavy, then it is a clue that the stock price is about to spurt.

PUTS (PEs)

Positive change in OI implies writers are selling the PE and this is because they feel the stock will not fall to the respective strike price. You also should note down the price where the highest change in OI is happening and treat it as a support level.

A negative change in OI implies writers are covering their shorted PEs because they feel the stock will fall. If the change in OI, in this case, is heavy, then it is a clue that the stock price is about to crash.

Conclusion:

Traders typically succeed about 50 percent of the time. The success percentage of amateur and beginner traders is way lower. Trading on charts alone is like flipping a coin and traders typically follow their eyes - they do not overthink a trade.

If a trader combines F&O data analysis with his chart analysis, his chance of succeeding can even go up to as high as 70 percent.

Try out the analyses suggested and see if it helps. I’m sure it will, but will wait for your feedback.

Sunil V Tinani is a Chartered Accountant and Investor who has been investing in the equity markets since 1985. He operates BullBull.in, a blog that guides investors through the dense stock market jungle.