How Do Traders Spot Opportunity in Option Chains?

Think an option chain is just rows of numbers? In this IBKR Podcast episode, returning guest Dmitry Pargamanik of Market Chameleon breaks down how traders read between the strikes – decoding volume, implied volatility, and the Greeks to uncover hidden signals, identify mispriced options, and turn raw data into high-conviction trade ideas.

Summary – IBKR Podcasts Ep. 376

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Jeff Praissman

Hey everyone, this is Jeff Praissman with Interactive Brokers Podcast. It’s my pleasure to welcome back to the IBKR Podcast studio Dmitry Pargamanik from Market Chameleon. How are you? 

Dmitry Pargamanik

Hey Jeff. 

Jeff Praissman

It’s always great to have you in the podcast studio. And, you know, for those who don’t know, Will and Dmitry, they do a daily show on YouTube as well as come in to do webinars with us the second Tuesday of every month. And then we, they always swing by the studio right afterwards to do a follow podcast. So, earlier today they came in and they talked about option chain analysis and interpreting, you know, price and risk and trading activity. And we’re gonna do a little bit of a, I guess, a different dive? 

Dmitry Pargamanik

Yeah. Yeah. We’re gonna get a little bit different perspective and, you know, go over some main questions that you have. 

Jeff Praissman

Well, I always kind of like to start from the beginning and know for our listeners who, you know, may have heard about options, but you know, maybe never actually traded them, could you just kind of briefly describe what is an option chain and, you know, why is it the tool that every option trader has open on their screen? 

Dmitry Pargamanik

When we were looking at options, really we have so many different options for a particular security. There needs to be a way to kind of just organize them in a standardized way so when people go and look at these options, it makes more sense. It’s organized, it’s easier to read, and that’s why we have an options chain, which really takes all these options, puts ’em into a table where it’s easy to view them, to find them, and to make evaluations on an option. So that’s really the standard way of looking at options for a particular stock. Right. 

Jeff Praissman

And, you know, when you pull up an option chain, like there’s the obvious, like the bid, ask, strike, and expiration, but you can also, you know, I know ones on Interactive Brokers are customizable. I’m assuming ones other places probably are too to some degree, but you can have a lot of data staring back at you, you know, prices, volume, the Greeks, implied volatility. In your opinion, you know, what are the three to four most important things someone should focus on? 

Dmitry Pargamanik

Yeah. I think unless you have a particular agenda you’re looking for, when you open up an option chain, I would say the first couple things that may stick out to get a sense of what’s going on is looking at the volume. So what are the corresponding volume to the options? If there’s any particular option that looks like it has more trading interests or concentration of trading interests, that might be something to look at. Or is the volume and trading activity distributed fairly equally or evenly through, you know, through the options? But volume is a big thing because, you know, something that you could kind of just scan with your eyes and if something pops out, that could draw your attention. 

The other thing is implied volatility, ’cause the implied volatility levels gives you an indication where the current expectations are that traders are building in, you know. So the implied volatility, the market’s forward-looking volatility in the underlying. And another thing, just if you kind of learn to scan with your eyes, is how’s the implied volatility structured relative to the different strikes? Because in options, when we see implied volatility, because we have different options, they could have different implied volatilities, and the structure or, you know, the skew, the smile can tell us a lot about how traders are building expectations. If you, we could have a flat skew or you could have an upward-sloping skew, a downward-sloping skew. You could have a smile where the wings slope up from the at-the-monies, which tells you something a little bit different based on how that implied volatility smile structure looks like. 

Jeff Praissman

Yeah, I was gonna say, you know, I always feel like every conversation I have about options, implied volatility always comes up, right? So they kind of just kind of sum up, like it really can, it really is for, you know, people new to this and even experienced traders, like, I think it’s fair to say it’s really the key to understanding whether or not you’re kind of paying too much or getting a good deal on an option. Is that a fair statement? 

Dmitry Pargamanik

Yeah, it’s a way to convert an option price to a relative value, because that’s easier to make an assessment or evaluation of an option because, you know, you have different strikes, different expirations, and the implied volatility. And then these, the options, you know, decay over time. So the implied volatility is a way where we could take the price, put it into an option pricing model, and get this implied volatility level, which then kind of standardizes how we look at the value of the options across the board, you know. So, for example, we could have two stocks, you know, one stock is $10 and a different stock is $100. But those are just prices. A relative value will give us, well, you know, that $10 stock is, you know, trading at a 100 P/E and the $100 stock is trading at a 10 P/E, so on a relative basis, the $10 stock seems like much more expensive relative to the earnings of the company. So that’s the idea there where we convert it to a relative value so we could kind of make a comparison of different options. So that’s kind of like the idea with implied volatility. 

Jeff Praissman

And, you know, option chains can really help the investor find pricing discrepancies as well, right? Like kind of using it for like comparison shopping, sort of as you kind of alluded to. You know, could you give us like another simple example of what, you know, price discrepancy would actually look like and how someone might be able to spot this in a chain? 

Jeff Praissman

Mm-hmm. And, you know, one thing, option chains also, you know, show—they not just show you one expiration, they show you all the expirations. And, you know, what can it tell you, like if you’re able to kind of, you know, compare these options and whether it’s the same strike or similar strikes throughout different months of expiration, you know, what does it tell you when you might see a weekly option showing, say, a 60% implied vol? 
A monthly option on the same stock and they’re at like a 35% implied vol, you know, is it something wrong or is there, you know, is there potential opportunity there? 

Dmitry Pargamanik

What that indicates is the market’s expectations of how volatility will change over time. So if we’re, for example, experiencing a very low volatility regime and maybe, you know, the traders right now don’t expect a lot of movements, maybe there’s a period where we don’t have, you know, earnings announcements or any kind of expectations of major economic announcements, and, you know, it could be the summer months, volatility may drop. And what you’ll see is on the lower end of the curve, implied volatility lower, but then we’ll see an upward—we’re looking as you go out further in time, you know, an upward-sloping structure, which says that’s not gonna last forever. Volatility eventually will either increase or, you know, there’s more uncertainty as we go out further in time. It could go the other way where, let’s say for an earnings or a period of high volatility or uncertainty, people are looking for short-term volatility, short-term protection, and they expect the volatility to start to not last or be sustained at these high levels. So you’ll see a downward-sloping term structure. So in earnings, that’s kind of what happens, where we see uncertainty because we’re gonna have an earnings announcement. We don’t know what the earnings release will be. Could be good, it could be bad, and we could see this short-term gap or really big move in a stock, but that’s not expected to last every single day. And after the earnings, you know, it will reprice and then kind of go back, revert to its normal volatility. So then you’ll see a downward-sloping implied volatility structure. So it’s really embedding traders’ expectations of volatility as you go out in time. 

Jeff Praissman

And, you know, we mentioned earlier that like, you know, not only is implied volatility, you know, shown on option chains, but, you know, Greeks are obviously a big function of it as well. And, you know, while there’s five of ’em, they’re probably—the three most popular ones are delta, theta, and gamma. Could you kind of just, you know, briefly just kind of tell our listeners, for those especially new to the option world, kind of what each one does, and you know, how you could potentially use ’em for like a price discrepancy, you know, or help guide you using ’em, you know, in the— 

Dmitry Pargamanik

Yeah. When we look at options themselves, they have different risk factors, different factors that can impact the price of the option. You know, one is direction—the stock could move up, it could move down. So options on different strikes could have different exposure to directional risk, and the delta is just telling you the sensitivity of that option to a $1 move in the stock. 

So if you have like a perfect one delta, then the option will move one-for-one with the stock. If you have a 50 delta, the option price will change by 50 cents for every dollar move in the stock. You know, a 20 delta option—the option is expected to change by 20 cents for a dollar move in the stock. And that’s based on nothing else changing, you know, just the dollar move in the stock—no time decay, no implied volatility changes. So that’s the directional risk. 

But besides directional risk, we know an option also has time decay. You know, what’s gonna happen to your option if nothing happens for the rest of the day? Let’s say you buy an option, it doesn’t go up, the stock doesn’t go up, it doesn’t go down. But the problem is options expire, you know, they’re not forever. These are securities and tools that have an expiration date. So as you get closer to expiration, you’re gonna lose premium. And that risk tells you, hey, you know, it’s Monday morning. If I buy this option and nothing happens, what am I expected to decay? You know, if the stock doesn’t move, implied volatility doesn’t move—if I buy it for a dollar, am I expected to, you know, lose 10 cents, 15 cents, 20 cents? You know, what’s my risk regarding this option? That’s kind of the theta, the time. Okay. 

And your gamma is telling you how much your delta will change for a $1 move in the stock. So that tells you the sensitivity of your portfolio as the stock moves. Are you gaining gamma, and at what rate? So, you know, the delta—when you have an option, you know, and it’s a 50 delta, doesn’t mean that it will always be a 50 delta forever. That is just at this point. As the stock moves, the delta can increase, it’s going up, you know, or decrease depending on where it goes. So that gamma is telling you the rate of change of your delta as the stock moves $1 higher, $1 lower. 

Jeff Praissman

Yeah, and you mentioned earlier, Dmitry, you know, volume is usually on option chains, open interest as well. A lot of times people get those too confused, but, you know, in reality they’re somewhat related, but they’re very different too, right? Like volume is the number of those contracts that traded that day, or open interest is really the total number of active option contracts. 

So, for our listeners, just in the simplest of terms, if I am long a July 55 call, and if I’m on one call and Dmitry does not have a position, I sell a call, he buys a call. The open interest actually stays the same because I’m actually closing my position, Dmitry’s opening his, so they’re very different. I think a lot of people get ’em confused, but they’re also two very important, you know, points of data that are available usually on option chains. And, you know, for those two, Dmitry, what should the traders look at? Like, can they spot, you know, can unusual activity, you know, create pricing discrepancies, you know, how would they spot this in an option chain? 

Dmitry Pargamanik

Yeah. It’s a good question because sometimes people do get confused about the volume and open interest and think that they’re kind of, like you mentioned, just a straight correlation. But they’re not. And the open interest—well, first of all, open interest only updates once a day. So that’s one thing that people do get confused—where, well, why isn’t open interest, you know, updating? Well, the way open interest gets updated is that it’s based on end-of-day settled trades. Those settled trades go to the OCC, it reconciles them, you know, if there’s any exercises, assignments, splits, does all that, and then releases the new open interest. But it doesn’t know the new open interest until the end of the trading day again, and options are settled. 

And that open interest just tells us how many options—whenever two people trade, you know, if there’s zero open interest, two people trade, they create a contract, right? That’s how you create a contract. One person buys, one person sells. Now you have a contract and it’s open interest until it expires or both of you close out. But like you mentioned, you know, if you and Will did a trade, you bought a contract and then Will sold a contract, and then you did nothing and Will said, well, I wanna buy my contract back, and he buys it from me. Well, we, the open interest didn’t change, right? It’s still one—it just transferred from one person to the other. So a new contract didn’t get created. Just one side of that contract transferred his risk to someone else, basically. But a new contract didn’t get created, but the volume will still reflect a trade. 

So the volume just reflects that, you know, those two trades. The open interest reflects the open contracts that have not yet expired or been closed out. So those are two different metrics. And open interest would let us know, well, how many contracts are out there? People are holding positions—that means there is risk on the books, right? So big open interest, there are lots of positions open in a particular contract. Zero means there’s no risk yet in that contract. Even if we see lots of trading during the day where people can have intraday risk, the carry risk going forward would be reflected in open interest. 

Jeff Praissman

And can you walk us through your, you know, your workflow when you open up an option chain and you’re looking for opportunities? What’s like your, you know, your step-by-step process from, you know, analyzing the data to, you know, sort of identifying potential trade? 

Dmitry Pargamanik

Yeah, you know, sometimes I just look at the options chain to get a quick assessment of what’s going on. Like we mentioned, you know, do I see any unusual type of trading activity, volume, or are the option prices lining up where they are skewed in a particular way that may, you know, warrant further research? Or is there—especially if you’re familiar with a certain security where you see it every day—you might start noticing things that you could only see from looking at it every day. You know, oh, I’ve seen this before, this is an opportunity, this is lining up differently, I should look at it further. 

So part of it is really the experience of seeing and watching and knowing what’s going on on a day-to-day basis. Most of the time I just check in to see what’s going on, get a quick assessment. If I see anything unusual, sometimes I go in there because I might have an idea or a particular outlook or strategy I have in mind, and I wanna see how the markets line up, you know, and if there’s a potential trading opportunity that fits my outlook. So those would probably be the most common, you know, go-to things that I would look at in the option chain. 

Jeff Praissman

Got it. No, that’s perfect. Dmitry, this has been great. You know, thanks for coming by. Any final thoughts you’d like to leave our listeners with? 

Dmitry Pargamanik

I think from the option chain perspective, if you are getting—or if you’re new to options, you’re starting to learn about options—I think it’s important to really get used to an option chain, understand what you’re looking at, you know, what it could reveal. Not every options chain is the same in perspective of these added values of, you know, analytics and risks and stuff. 

So as we see, typical things that are standard, right? You have prices, volume, last trade, things like that. But then, you know, a lot of options chains then have other added values. So getting to know the options chain, understanding it, and how to utilize it is really an important step before you do anything, because that’s gonna be your starting point really, you know, is that option chain. 

Jeff Praissman

This has been great. And you can catch more from Dmitry on YouTube every weekday morning at 9:00 AM, also on our website. Go to ibkr.com, click on education, go down to the campus, and you can see previous podcasts, previous webinars, and also look for upcoming webinars. It’s the second Tuesday of every month that they come by at 2:00 PM Eastern Time. Thanks. 

Dmitry Pargamanik

Thanks, Jeff. Thank you.