Open Interest

Open interest refers to the total outstanding or open contracts in a derivative market at any given time. The quantitative value shows the total number of contracts in the market that have yet to be liquidated. It is frequently observed in conjunction with data from the futures and options markets.

In combination with price and trading volume data, open interest helps investors better understand market sentiment and acts as guidelines for an investment decision. However, its value is sensitive to trading activities, and as a result, at the end of each trading day, the value may increase, decrease or remain unchanged.

• Open interest is explained as the total number of active contracts that have yet to be closed or settled.
• When a new buyer and seller enter into a contract, the OI will increase. As contracts are closed or exercised, the OI will decrease. However, when an old seller and a new buyer enter into a contract, OI remains unchanged.
• Open interest vs. volume indicates that OI isn’t the same as volume. Volume is the total number of contracts traded in a certain period, whereas OI is a running total of the active contracts.
• Traders and investors can look at OI in combination with other indicators like price or trading volume to better understand money flow in the stock market.

Open interest (OI) depicts the number of futures or options contracts open in the market at a specific time while trading in derivatives, such as futures and options, open interest tells us the number of futures or options contracts open in the market at a specific time. It starts with the seller and buyer meeting to initiate a new contract. Then, throughout the trading day, as these contracts are opened, they will tally them based on the trading activities like settling the contracts.

At the end of the trading day, the clearinghouses of financial market consider the number of new contracts open and closed throughout the day. For every new contract opened, an OI gets added, while every contract that closes is subtracted from the total OI. It happens because contracts are counted as open and included in the OI until the other party closes it or the contract expires.

Consider a scenario of a new buyer and new seller meeting, and if both traders open a new position, open interest increases. When an old buyer and old seller close an existing or old position, open interest decreases. If an old buyer sells to one new buyer, the open interest will not vary since the trader transfers his position to a new trader.

The expression below shows the equation that can help traders figure out the total number of outstanding contracts:

OI = Sum of the number of active/open trades – Sum of the number of contracts that have expired/closed

Let us consider the following example to check how to calculate open interest. Suppose, there are three traders A, B, and C, taking the following trades:

• Nov 1: Seller A and buyer B initiate a new contract. The volume and OI created in the trade is seven.
• Nov 2: B is selling two of his existing contracts to C. In this case, no new contract occurs; instead the existing one is passed to a new buyer, C. Hence the OI remains the same. However, the volume created in the trade is two.
• Nov 3: C is an old seller, and A is an old buyer. When A buys two contracts from C, the closing of two open positions occurs. Both of them closed their existing positions. Hence OI reduces by two. The volume created in the trade is two.

Open interest for options and futures helps traders be aware of the number of outstanding or open contracts at the end of a trading day. It helps traders learn about the market situation at a given point in time. Thus, for an investor to understand how things are working in the market, they must know how to read the data obtained.

For a valid open interest analysis, one must know that:

• A high OI helps traders expect a considerable move in the market soon. Such value encourages more traders to enter the market.
• On the other hand, a low OI makes traders aware that the trading options would be limited, This, as a result, affects the liquidity level of the market and leads to the traders’ exit.

The concept can be supported by the chart taken from Tradingview, as given below. The chart indicates the price sentiments of the traders and the total number of active contracts in the market for that particular financial instrument. It helps interpret both long and short positions to analyze market activity. The histogram given below is the indicator for open interest, where an increase will denote that the market is getting a fund inflow, which in turn shows an increase in activity and trending conditions. The opposite will happen if the open interest is decreasing.

Therefore, it signifies a correlation between the new position that the traders have taken and the existing positions. The deviation from the 0 line shows how much or to what extent the inflow or the outflow is taking place. Along with the histogram, the price chart of the candlesticks indicates how the market players, that is, the bulls and the bears, are proceeding in the market and who is more powerful. Thus, it is extremely important to understand the correlation between open interest and the volume of trade.

Source

Traders often use OI in combination with price and trade volume daily as a part of their trading strategy to determine price trends and reveal engagement around a particular derivative contract. It is always a part of option quotes along with elements like volume, bid, and ask price. For instance, on Nasdaq’s financial website, the option chain for particular security integrates OI data. The following table presents a few commonly accepted guidelines that indicate the overall scenario and help traders determine when to enter or exit a position.

When price and OI increase, technical analysts infer that the trend continues since the strong bullish sentiment and more traders will open new contracts. When price increases and OI decreases, technical analysts infer that the particular trend is weakening. Decreasing OI is an indicator of market participants closing their position. When the price decreases and the OI value increases, technical analysts infer that the particular trend is weak. When the price and OI value decrease, traders conclude that the specific trend is strengthening and will reverse.

This has been a guide to what is Open Interest. Here we explain how to read it along with an example, how to use it, and its formula. You can learn more from the following articles –

• Open Market Operations
• Futures Market
• Options Spread