Open Interest in Options

Open Interest (OI) is a crucial concept in the world of futures and options trading. A futures contract binds the buyer to buy and the seller to sell and deliver a certain asset at a predetermined future date. An option allows the buyer the choice to purchase (or sell) an asset at a predetermined price at any point during the term of the contract, but it does not obligate them to do so.

Open Interest represents the total number of contracts that are currently held by market participants and have not yet been offset by closing trades. Unlike trading volume, which measures the number of contracts traded during a specific period, open interest focuses on the total number of contracts that are still "open" or outstanding.

Open Interest (OI) is a metric that quantifies the total number of futures or options contracts actively in circulation within the market. It's important to note that every trade involves two parties: a buyer and a seller. For instance, when a seller offers and a buyer acquires a single contract, the buyer holds a long position in that contract, while the seller takes a short position. In this scenario, the open interest is recorded as 1, signifying the existence of an active contract on the market. Now you have a better understanding of what is oi in option chain.
 

What is Open Interest in Options?

Open interest meaning refers to the total number of active contracts in the futures or options market that haven't been settled yet. It shows how much money is currently invested in these markets. Each contract has both a buyer and a seller, but we only need to count one side to find the total open interest.

This figure helps traders understand market trends. For example, if open interest is increasing, it means more people are entering the market, which could strengthen the current trend. If it's decreasing, it might signal that the trend is losing momentum.

Each day, open interest is reported as either increasing or decreasing, showing whether more contracts were opened or closed. This information is valuable for traders to gauge the market's direction.

Importance of Open Interest

Now that we've covered what is open interest, let's understand its importance. Open interest is a term used in trading to measure how active a market is. It shows the number of contracts (futures or options) that are still open or active. When there’s low open interest, it means most positions have been closed, indicating less activity in the market. On the other hand, high open interest means many contracts are still active, signaling more activity and attracting more attention from traders.

Open interest also reflects the flow of money in and out of the market. When open interest increases, it means new money is entering the market. If it decreases, it shows money is leaving the market. For options traders, open interest is crucial because it provides important information about how easy it is to buy or sell options, known as liquidity.
 

Key Takeaways

Open interest accumulates as new contracts are initiated and decreases when existing contracts are offset or closed.
Trading volume represents the total number of contracts traded in a given time frame (in this example, daily).

Open interest provides insight into the total number of outstanding contracts in the market, while trading volume shows the number of contracts traded during the specified time frame.

Monitoring both open interest and trading volume can help traders and analysts gauge market sentiment and participation.

In practice, traders and analysts use historical open interest and trading volume data alongside price charts to make informed trading decisions and identify potential trends or reversals in the market.

Key Points

1. Outstanding Contracts: Open interest reflects the number of outstanding contracts in the market at a given time. It provides insight into the level of participation and interest in a particular futures or options contract.

2. Two Sides to a Trade: Every futures or options trade involves two parties, a buyer (long) and a seller (short). The open interest increases by one contract each time a new trade is initiated.

3. Stays Open Until Offset: A contract remains open until it is offset by an equal and opposite transaction. For example, if Trader A decides to sell the same futures contract they bought earlier, the open interest on that contract would return to zero for that specific trader.

Take a look at the illustration below:

As of 20th October, OI on HDFC Bank futures is roughly 5.35 Crores. It means that there are 5.35 crore Long Nifty positions and 5.35 crore Short Nifty positions. Also, about 1.72 crores (or 47.52% over 2.78Crs) new contracts have been added today.OI is a great tool for figuring out how liquid the market is. The market is more liquid, the larger the open interest. Consequently, it will be simpler to initiate or exit trades at attractive ask/bid rates.
 

Differences Between Open Interest and Trading Volume

While both open interest and trading volume provide valuable information about market activity, they serve different purposes:

1. Open Interest: Reflects the total number of contracts that are currently open and outstanding in the market. It is a lagging indicator, meaning it provides information about existing positions rather than recent trading activity.

2. Trading Volume: Measures the number of contracts traded during a specific time frame, such as a day or a trading session. It is a real-time indicator that shows the level of buying and selling activity in the market.

How To Calculate Open Interest

To calculate open interest, you add up the total number of outstanding contracts (futures or options) that are still open or active at the end of the trading day. It’s important to note that open interest increases when new contracts are created and it decreases when contracts are closed or settled. If one trader opens a new position by buying a contract and another sells to close their position, the open interest remains unchanged. However, if both traders open new positions, the open interest increases by one. This calculation helps gauge market activity and liquidity.

Benefits of Using Open Interest and Trading Volume Data

Understanding open interest and trading volume data can be beneficial for traders and investors in several ways:

1. Market Sentiment: High open interest combined with increasing trading volume may indicate strong market interest and potential price trends. Conversely, declining open interest may suggest waning interest in a contract.

2. Liquidity Assessment: Trading volume helps assess the liquidity of a contract. Contracts with higher trading volumes tend to have narrower bid-ask spreads and lower transaction costs.

3. Confirmation of Trends: Analyzing open interest alongside price movements can help confirm the strength or weakness of a trend. For example, if prices are rising, and open interest is also increasing, it may indicate a sustainable bullish trend.

4. Contrarian Indicators: In some cases, high open interest levels can signal market extremes and potential reversals. Traders may use open interest data as a contrarian indicator when it reaches extreme levels.
 

How do traders use open interest data in their trading strategies?

1. Rising OI and Markets:

Rising open interest and price action during an uptrend are seen as signs of new money entering the market. That shows that the market is bullish, which is bullish.

2. Declining OI and Rising markets:

If price action is increasing while open interest and volume are decreasing, the price rally is being driven by short sellers covering their bets. Money is consequently exiting the market. This is seen as a bearish sign by traders.

3. Rising OI and Falling Markets:

Some traders think new money is entering the market when prices are falling and open interest and volume are increasing. The pattern, in their opinion, points to an aggressive new short-selling strategy. This situation is predicted to result in a downtrend's continuation and a bearish condition.
 

4. Falling OI and Markets:

Last but not least, if open interest and volume are reducing and prices are falling, it is probably because holders of long holdings who are unhappy with the market are being pushed to sell their positions. Because they believe the downtrend will finish once all the sellers have closed their positions, some technicians see this scenario as a solid position.
 

Open Interest Indicators

The following methods will help you maximize Open Interest in intraday trading:

1. Confirming Breakouts: If the Open Interest is increasing in tandem with a stock price breakout from a key resistance level, this is a confirmation of the breakout. Increased Open Interest and a breakthrough point to a greater likelihood of the trend continuing.

2. Divergence Analysis: Look for divergences between price and Open Interest patterns. When the price is hitting higher highs but the Open Interest is falling, it may be an indication that the trend is about to reverse.

3. Options Trading: Monitoring Open Interest is essential for intraday option traders. For particular options contracts, changes in open interest can offer clues as to how smart money is positioned.
 

Conclusion

In conclusion, open interest is a valuable metric for traders and investors to gauge market participation and sentiment in futures and options markets. When used in conjunction with trading volume data, it can provide valuable insights for making informed trading decisions. Monitoring these metrics can help traders identify potential opportunities and risks in the market.