12 - How to Identify a Range-Bound Market or a Trending Market for Option Buying

 

How to Identify a Range-Bound Market or a Trending Market for Option Buying

In today’s lesson, I’m going to teach you how to identify whether the market will be range-bound or trending. This is crucial because for options buyers, a trending market is essential. On range-bound days, we should avoid option buying. So, let’s dive into how you can identify this!

Let me give you an example. Today, as I record this lesson, there were expirations for two major indices: the Bank Nifty and the Midcap. Now, if you look at the Bank Nifty, you’ll notice that it was range-bound for most of the day. Despite the fact that the Bank Nifty index is huge (over 59,000), the entire day’s range was just around 150 points—this is extremely small for an index of this size. In comparison, the Midcap index, which is around 13,000, had some volatility with an 80-85 point move, meaning it wasn’t range-bound like the Bank Nifty.

So, how can we identify this beforehand? Here's the trick: we need to analyze the option charts of the index we are tracking. Let's take Bank Nifty as an example. In the morning, the market might rally, but the key is to look at what happens post-10:30 AM.

Step 1: Analyze the Call and Put Premiums

When the market is trending, you will see the premiums (prices) of both calls and puts either increasing or decreasing based on the direction of the market. But when the market is range-bound, you’ll notice that neither of the premiums rises significantly; instead, they decay slowly.

For example, if you look at the Bank Nifty call chart around 10:30 AM, you’ll see that the value of the 59,200 call option starts to decrease gradually. Similarly, if you look at the 59,200 put option, you’ll notice the same thing happening. This slow decay in premiums indicates that the market is likely range-bound.

Step 2: Check the Total Premium

The total premium is the sum of the call and put premiums. On a range-bound day, the total premium will be quite low. For example, in the Bank Nifty, the combined premium (call + put) was just around 150 points by 11:00 AM. This is unusually low for an index of this size. In comparison, when the market is trending, premiums will usually be higher.

Step 3: Observe the Price Movement

The movement in prices will also give you an idea. If the market is range-bound, the prices will stay within a small range and not make big moves. In the Bank Nifty today, despite the large size of the index, the total price movement was less than 150 points, indicating a range-bound market.

Step 4: Compare with Other Indices

Now, let’s take a look at the Midcap index, which had an 80-85 point move, compared to Bank Nifty’s 150 points range. Midcap's movement was more significant, indicating it was not range-bound like the Bank Nifty. This gives you an important insight: when the premium is higher and there’s noticeable price movement, the market is likely to be trending.

Step 5: Look for Similar Patterns

If you observe a market where both call and put premiums are low and slowly decaying, you should expect the market to remain within a range for the day. Conversely, if there’s noticeable movement in the premiums (either increasing or decreasing), then you can expect a trending market.

Example of a Range-Bound Market

Let’s go back to Bank Nifty. In the morning, there was some volatility, but after 10:30 AM, there was no significant movement. The premiums of the call and put options were not increasing, which clearly indicated that the market was range-bound. If you had analyzed the charts, you would have realized that today, option buying in Bank Nifty wasn’t the best strategy.

Conclusion

To identify whether the market is range-bound or trending, focus on the following key factors:

1. Check the call and put premiums: If both premiums are low and decaying slowly, the market is range-bound.
2. Look for price movement: In a trending market, you will see more significant price movements.
3. Compare with other indices: If one index has low premiums and little movement while others show more volatility, the first index is likely range-bound.

By following these steps, you can avoid option buying on range-bound days and ensure you are trading when the market is moving in your favor. So, next time, before executing an option trade, take a few minutes to analyze the market’s behavior and ensure it’s trending. This will help you make smarter, more informed decisions.

Keep this strategy in mind, and you’ll have a much clearer approach to identifying whether today’s market is suitable for option buying or not.