Options Technical Analysis - What Do I Need To Know About Options Trading Charts?
Summary: This is a gentle introduction to the technical analysis of options using a variety of
charts and partterns.
There exist today an array of charts, patterns and statistical analyses large enough to please even a Medieval numerologist. Though it
often looks and reads much like mathematical tea-leaf reading, most of the commonly used tools are based on serious empirical studies of the
The best way to explain what technical analysis is may be to contrast it with its arch-rival and sometimes partner: Fundamental Analysis.
Fundamental analysis consists of attempting to evaluate a financial instrument (a stock, bond, etc) by looking at factors affecting intrinsic
worth. Company earnings, basic industry conditions - everything from the overall economy to who sits in the Chief Financial Officer's chair.
Technical analysis shuns measurements of such things as assets and liabilities and focuses less on company or industry specifics. It looks
instead for statistical patterns among historical (both recent and long term) price movements, volume and a large number of other variables.
Some of these variables and patterns appear arcane to all but the specialists. Fortunately there are a few basic ones available to the savvy
but still mere mortal.
One of the most basic is the simple bar chart. In use for centuries in one form or another, it consists of the familiar vertical stick with
small horizontal tick marks attached.
The length of the bar shows the price range of the instrument for a recent period - usually the last 24 hours or the trading day up to that
point. The horizontal mark on the right indicates the opening price, the left-pointing one shows the closing price.
A series of these laid out across a chart - for periods of a week, a month, quarterly, etc - forms a pattern. It's that pattern that the
technical analyst uses (in part) to predict how the pattern will continue - i.e. what the price will be an hour or a day or a few weeks
Traders who rely heavily on technical analysis are rarely long term players. Somewhat like predicting the rain, a set of data can help you
guess with high probability what will happen in the short term. It's less useful for judging the outcome three months ahead.
Candlesticks - adapted from the Japanese, where they were used to forecast rice futures - are a common variation. The change consists
essentially of 'fattening' the vertical stick and adding color to indicate variations between opening and closing prices.
Red strips are used to show a closing price lower than the previous period, green when the instrument closed higher. Again, different shapes
suggest - to the initiated - different market movements.
Since options, like bonds, add the element of time expiration new variables to predict patterns come into play. Also, since as a derivative an
option has no intrinsic worth, price and volume changes can (and do) occur as a result of changes to the underlying asset.
Some of the variables that measure these changes make their way into technical analysis charts.
Delta, for example, measures how much an option price rises or falls relative to the change in price of the underlying asset. Theta measures
how much an options position gains or loses in a period of time - a day, a week, a month, etc. Vega is a measure of how much a position
gains or loses as volatility changes by a specified percentage.
Fortunately, there are software packages available that will allow tracking of these and other variables. Algorithms are built in that experts
assert indicate thresholds and patterns that signal buy or sell.
Since there are dozens of such offerings, containing hundreds of different variables and patterns, only experience can teach you which are
meaningful and which mere numerology.