What Does Support Mean?
Support is a price level on a stock chart where historically the stock has had difficulty falling below. The price level acts as a floor and prevents the price of the stock from falling any further.
There are two ways the stock will test this level of support:
- Either the stock will fall to this level and then “bounce” off of it and begin to rise again or…
- The stock will fall to this level, break through it, and continue dropping until it finds another level of support, a resting spot so to speak.
The more times a stock falls to the level of support and bounces off it, the more significant (stronger) the price level becomes.
What Does Resistance Mean?
Resistance in a sense is the opposite of support. Resistance is a price level on a chart where historically the stock has had difficulty rising above. This price level acts as a ceiling and prevents the stock from rising any further.
The stock price will test the resistance area in the same two ways as it does an area of support. Either it will bump up against it and reverse in the down direction, or it will break through it and continue rising.
A resistance level is created at a point where “selling pressure” exceeds buying pressure and the rally in stock price is halted and vice versa for supports.
The stock will rise to a certain point. People who believe the stock has peaked will begin to sell, which in turn causes the stock to reverse and fall in price. Or break through if these levels are no longer significant.
Options-Related Support and Resistance
In derivatives, one of the important indicators for support and resistance is high or maximum OI of call and put option. Open Interest (OI) is a number that tells you how many futures (or Options) contracts are currently outstanding (open) in the market.It indicates that at what level traders have built positions expecting the Nifty to either go up or down.
Large call open interest can often act as options-related resistance , especially at slightly out-of-the-money strikes among shorter-dated options. For example, let’s assume that you purchase an ABC June 40 call. On the other side of that trade are the option sellers, who must purchase shares of ABC in order to offset their position. As the stock approaches the 40 level, the option writers will begin to unwind their hedges in order to remain delta neutral, thus applying pressure to the underlying shares.
Meanwhile, heavy put open interest can often act as options-related support . This is also partially due to the dynamics of options hedging, as traders sell puts in order to minimize exposure to risk and remain market-neutral.
In order to balance their sold positions, put writers might sell the underlying stock short. When the options expire or when the put buyers unwind their positions, the short interest on the equity will ultimately be repurchased, which can add to the buying pressure as the underlying shares approach noteworthy strikes.
Suppose, in the options segment for the maximum open interest among Nifty put options is at 10,800 strike, while the highest open interest among call options is at the 11,000 strike. This means the resistance of Nifty is at 11,000 and support at 10,800. This implies that option sellers have built maximum positions at the 11,000 call and the 10,800 put.
The average price per share of the 10,000 call option since the beginning of the current expiry is Rs 50. This means the seller will begin to encounter loss once the Nifty breaches 11,050 (11,000 +50). This will force the sellers to cover their short positions, driving the Nifty higher towards 11,100.
On the flip-side, option sellers have sold the maximum puts on Nifty at 10800 level. The average price per share of this option was Rs 83, making the seller’s breakeven below which she/he encounters losses at 10,717(10800-83). Short covering by sellers could result in a correction till 10,650.
However, not all “heavy” open interest will translate into support or resistance. To gauge if a particular strike is likely noteworthy enough to impact the charts : first, tally the number of open contracts at that strike; then, multiply that number by 100, as each contract represents 100 shares of the underlying stock; finally, if that number of shares represents at least 10% of the security’s average daily trading volume, the strike could play a technical role going forward.
One could also compare these to charts to see where price action has been higher OR where significant earlier tests have happened. One could also see which strike’s neighborhood has the Options OI activity been very aggressive.
Traditionally, round-number levels are especially more likely to act as options-related support and resistance. Investors generally view these psychologically significant levels as good closeout points for short positions, meaning they’re more likely to sell when the shares get to 90 or 100, than, say 83 or 107.
Why is Options OI Better than Volumes
We believe that open interest (rather than options volume) is the best tool for analyzing option activity. It is a much more stable number and it reflects what option traders are doing “at the end of the day.” Large volume could be indicative of transient day-trading activity (which has no impact on open interest) or could reflect traders closing existing positions (so if there is big put volume on a given day, this could be simplified as a reflection of bearish sentiment, when in fact it indicates that bearish bets are being closed).
Certain support and resistance levels are more important than others. The significance of the level depends on the following factors:
- The number of times the level has been tested. The more it has been tested (bumped up against) the stronger it becomes in holding the stock back.
- The amount of volume that has been traded near the level, the higher the volume the more traders are participating in the move.
- Whether the level is old or new (recent levels have greater significance).
- Whether the level is a new High or new Low, more extreme levels have greater impact.
- A level formed at a round number leaves a lasting imprint.