Chapter 3 | Defining Support and Resistance

In AOC Support and Resistance are easy to find you can find it displayed on the top header of the software. Here is a screenshot showing support and resistance in AOC.

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But our goal here is to learn and understand what Support and resistance are. Lets try to break them down and understand one by one.

1. Support

Support is a price level at which a stock or other asset tends to stop falling because there is a concentration of demand at that level. When the price approaches support, traders expect it to be more likely to “bounce” upwards rather than break through.

Support in terms of Option Chain

In the context of an option chain, support can be inferred by analyzing the open interest and volume at different strike prices.

Key characteristics of support in an option chain:

1. High Open Interest at Lower Strikes: A high number of open interest (OI) at lower strike prices for put(PE) options can indicate potential support levels. This is because sellers of puts (often institutions) expect the price to stay above these levels and are willing to take on the obligation to buy the stock if it falls to these prices.
2. Put/Call Ratio: A low put/call ratio at certain strike prices can indicate strong support levels, as it reflects a higher number of calls relative to puts, showing bullish sentiment.
3. Volume Analysis: High trading volumes in put options at certain strike prices can also suggest where traders expect the price to find support.
4. Implied Volatility (IV) Analysis: Lower IV at certain strike prices can sometimes indicate lower expected volatility and potential support, as there’s less anticipation of large downward moves.

1.1 Support in Terms of AOC

Now that we have basic understanding of what Support is lets extend this knowledge to better understand Support in Terms of AOC.

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1.2 The Definition

The Strike Price starting from one In The Money (1-ITM) towards Out of The Money (OTM) which which has either Volume , OI, OI Change percentage is. 100% and is closed to the Spot Price is our support. Following are the key points to remember when defining support.

1. Volume , OI, OI Change they can make support all 3 on the same strike price.
2. Any two of them or
3. Any one of them

Learn more bout ATM, OTM and ITM here.

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2. Resistance

Resistance is a price level at which a stock or other asset tends to stop rising because there is a concentration of supply at that level. When the price approaches resistance, traders expect it to be more likely to “bounce” downwards rather than break through.

Resistance in Option Chain

In the context of an option chain, resistance can be inferred by analyzing the open interest and volume at different strike prices.

Key characteristics of resistance in an option chain:

1. High Open Interest at Higher Strikes: A high number of open interest (OI) at higher strike prices for call options can indicate potential resistance levels. This is because sellers of calls (often institutions) expect the price to stay below these levels and are willing to take on the obligation to sell the stock if it rises to these prices.
2. Put/Call Ratio: A high put/call ratio at certain strike prices can indicate strong resistance levels, as it reflects a higher number of puts relative to calls, showing bearish sentiment.
3. Volume Analysis: High trading volumes in call options at certain strike prices can also suggest where traders expect the price to encounter resistance.
4. Implied Volatility (IV) Analysis: Higher IV at certain strike prices can sometimes indicate higher expected volatility and potential resistance, as there’s more anticipation of large upward moves being capped.

2.1 Resistance in terms of AOC

Now that we have basic understanding of what Resistance is lets extend this knowledge to better understand Resistance in Terms of AOC.

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2.2 The Defination

The Strike Price starting from one Out of The Money (1-OTM) towards In The Money (ITM) which which has either Volume , OI, OI Change percentage is. 100% and is closed to the Spot Price is our resistance. Following are the key points to remember when defining support.

1. Volume , OI, OI Change they can make support all 3 on the same strike price.
2. Any two of them or
3. Any one of them

Learn more bout ATM, OTM and ITM here.

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But why do we consider Volume, OI and OI Change for Support and Resistance

Lets try to understand why are these used for defining our support and resistance.

1. Volume

In the context of an option chain, volume refers to the total number of contracts traded for a particular option (both puts and calls) during a given trading session. It is a key metric that provides insight into the level of trading activity and investor interest in specific options.

Key Points About Volume in Option Chains:

1. Indicator of Activity: High volume indicates a high level of trading activity and interest in a particular option, suggesting that many traders are actively buying and selling that option.
2. Liquidity: Higher volume generally means higher liquidity, making it easier to enter and exit positions without significantly affecting the price. Liquid options typically have tighter bid-ask spreads.
3. Market Sentiment: Analyzing volume can give clues about market sentiment. For instance, unusually high volume in call options might suggest bullish sentiment, while high volume in put options might indicate bearish sentiment.
4. Confirmation Tool: Volume can help confirm the strength of a price move. For example, a price breakout with high volume is generally considered more reliable than a breakout with low volume.
5. Comparison with Open Interest: Volume is often analyzed in conjunction with open interest (the total number of outstanding contracts that have not been settled). A rising volume with increasing open interest typically indicates new positions being taken, while rising volume with decreasing open interest may suggest positions being closed.

Thats all well known definition but how does it act as support and resistance?

Lets look at volume in terms of AOC. Volume is the sum of all the trading activities being performed at any given strike price, in AOC we call it भीड़ ie. crowd. The market never wants to give money to the mass crowd.

Thus if at a strike price lets say 23500 there is maximum volume on call side, and our understanding is the market would not like to give money(profit) this crowd. And the crowd will get money only when the market goes above that strike price in other words people at 23500 CE will only get money if it becomes ITM (In The Money), to stop the crowd from getting money market will most likely reject from the AOC elastic end of that strike price thus its our resistance.

Similarly if a strike price lets assume 23000 has highest volume in Put (PE) side the market would most likely bounce up from that strike price’s elastic value to keep people in PE for that strike price from gaining profit.

2. OI and OI Change

In the context of an option chain, Open Interest (OI) and OI Change are important metrics that provide insight into the trading activity and market sentiment for options contracts.

Open Interest (OI)

Open Interest (OI) refers to the total number of outstanding options contracts (both calls and puts) that have not been settled or closed. It represents the total number of contracts that are currently open and active in the market.

Key Points About Open Interest:

1. Indicator of Market Activity: High open interest indicates a large number of outstanding contracts, suggesting a high level of interest and participation in a particular option.
2. Liquidity: Options with higher open interest are typically more liquid, making it easier for traders to enter and exit positions without significantly impacting the price.
3. Sentiment Gauge: Changes in open interest can provide clues about market sentiment and the behavior of traders.

OI Change

OI Change refers to the change in open interest from the previous trading session. It indicates whether new contracts are being created or existing contracts are being closed out.

Key Points About OI Change:

1. Positive OI Change: An increase in open interest (positive OI change) suggests that new positions are being created. This can indicate growing interest and potentially a continuation of the current trend.
2. Negative OI Change: A decrease in open interest (negative OI change) suggests that existing positions are being closed out. This can indicate decreasing interest and potentially a reversal or weakening of the current trend.
3. Volume vs. OI Change: While volume indicates the total number of contracts traded during a session, OI change shows whether those trades resulted in new positions or the closing of existing positions.

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The only difference between OI and OI Change is that OI is sum of all the open contacts from the day of trading opened for that contract where is OI Change is intraday sum of open contracts.

Now lets understand why OI and OI Change acts as Support and Resistance

OI and OI Change represents the open positions of Option Writers. In Indian market to write (create a open contract) the margin requirement is very high. For example to buy one lot of NIFTY if the buyer requires 5,000 rupees the option writer requires nearly 75 to 80,000. Since the margin requirement for option writing is very high, only few institutions or pro traders (FII, DII and PROs) are involved in option writing. They would not like to lose money and they have the ways to keep market in their favor.

Lets expand this knowledge to better understand OI and OI Change. If at a strike price lets say 23500 there is maximum OI or OIChange on call side, and our understanding is that these writers would not like to lose money. And the they will lose money only when the market goes above that strike price in other words it becomes ITM (In The Money), to stop market moving above that strike price option writers the big money , the smart money will most likely pull back the market below that strike price elastic end.

Similarly if a strike price lets assume 23000 has highest OI or OI change in Put (PE) side the market would most likely bounce up from that strike price’s elastic value to keep option writer in PE for that strike price in profit.