Relative Strength Index

The Relative Strength Index (RSI) is a momentum oscillator that measures the speed and magnitude of price changes, helping traders identify overbought and oversold conditions.

Developed by J. Welles Wilder in 1978, RSI oscillates between 0 and 100, with readings above 70 traditionally indicating overbought conditions and below 30 suggesting oversold. For option traders, RSI provides crucial timing signals – when to sell calls into strength or puts into weakness. Understanding RSI helps avoid selling premium against strong momentum and instead positions trades when exhaustion is likely, dramatically improving win rates and reducing stress.

It is a lower indicator that is plotted below the price action of stock price charts.

How RSI Works

RSI calculates momentum using average gains versus losses:

The Calculation

  1. Calculate average gain over period (typically 14)
  2. Calculate average loss over period
  3. RS = Average Gain / Average Loss
  4. RSI = 100 – (100 / (1 + RS))

The result smooths price action into a single momentum line.

RSI Scale Interpretation

  • 0-30: Oversold zone (bounces likely)
  • 30-70: Normal trading range
  • 70-100: Overbought zone (pullbacks likely)
  • 50: Midpoint (neutral momentum)

These aren’t rigid rules but probability zones.

RSI Settings and Timeframes

Default settings work but can be customized:

Period Length

  • 14 periods: Wilder’s original (balanced)
  • 9 periods: More sensitive, more signals
  • 21 periods: Smoother, fewer whipsaws
  • 5 periods: Ultra-short term (day trading)

Shorter periods = more signals but more false readings.

Timeframe Selection

  • Daily RSI: For monthly options
  • Hourly RSI: For weekly options
  • 15-minute RSI: For day trading
  • Weekly RSI: For LEAPS or investing

Match RSI timeframe to your option duration.

RSI for Option Sellers

RSI excels at timing premium sales:

Selling Puts on Oversold

When RSI drops below 30:

  1. Stock momentum exhausted downward
  2. Bounce probability increases
  3. Fear drives up put premiums
  4. Ideal put selling opportunity

Example Setup:

  • Stock falls 10% in 3 days
  • RSI hits 25 (oversold)
  • IV elevated from fear
  • Sell OTM puts into panic

Selling Calls on Overbought

When RSI exceeds 70:

  1. Stock momentum exhausted upward
  2. Pullback probability increases
  3. Greed drives up call premiums
  4. Ideal call selling opportunity

Example Setup:

  • Stock rallies 15% in week
  • RSI hits 75 (overbought)
  • FOMO buyers active
  • Sell OTM calls into euphoria

RSI Divergences

The most powerful RSI signals:

Bullish Divergence

Price makes lower low, RSI makes higher low:

Bearish Divergence

Price makes higher high, RSI makes lower high:

Divergences often precede major moves.

RSI Support and Resistance

RSI itself has technical levels:

Common RSI Levels

  • RSI 50: Acts as support in uptrends, resistance in downtrends
  • RSI 40: Bear market support (rarely exceeds in downtrends)
  • RSI 60: Bull market resistance (rarely breaks in uptrends)

These levels help define market character.

Trading RSI Levels

Bull market put selling:

  • Wait for RSI to hit 40-50
  • Uptrend support likely
  • Sell puts below price support
  • Higher probability trades

Advanced RSI Strategies

Beyond basic overbought/oversold:

RSI Range Rules

Strong uptrend: RSI 40-80 range

  • Below 40 = oversold in uptrend
  • Sell puts at RSI 40-50
  • Avoid selling calls until 80+

Strong downtrend: RSI 20-60 range

  • Above 60 = overbought in downtrend
  • Sell calls at RSI 50-60
  • Avoid selling puts until 20-

Multi-Timeframe RSI

Combine different timeframes:

  • Daily RSI oversold
  • Weekly RSI midrange
  • Hourly RSI turning up
  • High probability put sale

Alignment increases reliability.

Common RSI Mistakes

Oversold Can Get More Oversold: Don’t fight strong trends Ignoring Trend Context: RSI 70 in uptrend ≠ RSI 70 in downtrend Too Short Period: 5-period RSI whipsaws constantly Single Indicator Reliance: Combine with price action

RSI with Other Indicators

Powerful combinations:

RSI + Bollinger Bands

  • RSI oversold + Lower band touch
  • Double confirmation
  • Sell puts with confidence
  • Stack probability factors

RSI + Moving Averages

  • RSI oversold + Bounce off 50 MA
  • Trend and momentum align
  • Premium selling sweet spot
  • Risk clearly defined

RSI + Volume

  • RSI extreme + Volume spike
  • Capitulation identified
  • Reversal highly probable
  • Size up positions

Building an RSI System

Systematic approach for options:

Weekly Put Selling with RSI

  1. Screen for RSI < 30 on quality stocks
  2. Verify uptrend intact (above 200 MA)
  3. Check for support levels nearby
  4. Sell 0.20-0.30 delta puts
  5. Target 1% weekly returns

Rules for Consistency

  • Never sell puts above RSI 70
  • Never sell calls below RSI 30
  • Exit if RSI divergence appears
  • Size down in extreme readings

RSI Limitations

Understanding what RSI can’t do:

Trending Markets: Can stay overbought/oversold for weeks News Events: Fundamentals override technicals Low Float Stocks: RSI less reliable Choppy Markets: Constant false signals

RSI is a tool, not a crystal ball.

Key Takeaways

Relative Strength Index (RSI):

  • Momentum oscillator (0-100)
  • Above 70 = overbought
  • Below 30 = oversold
  • Divergences signal reversals
  • Excellent for timing options
  • Combine with other indicators
  • Respect trend context

RSI is one of the most valuable tools for option sellers, providing clear signals for when to sell premium into exhausted moves. Master RSI’s nuances – especially divergences and trend-relative readings – and you’ll dramatically improve your entry timing. Remember: RSI shows momentum conditions, not guarantees. Use it to stack probability in your favor, not as a standalone decision maker.