What is Open Interest
“Open interest is like a window into the soul of the market – it shows us who’s buying, who’s selling, and who’s just standing by the sidelines, waiting to see what happens next.”
What is Open Interest?
Open interest is a term that is often used in the world of options trading.
It refers to the total number of outstanding derivative contracts i.e futures or options contracts that are currently outstanding and have not yet been closed or settled.
Here are some key points to understand about open interest:
- Open interest represents the number of derivative contracts outstanding in a market.
- When a trader buys an options contract, a new position is created and added to the open interest.
- When a buyer and seller initiate a new contract, the open interest will increase by one contract.
- Similarly, when a trader sells an options contract, an existing position is closed, and the open interest is reduced.
- When a buyer and seller exit a contract, the open interest will increase by one contract.
Open interest is an important indicator of market activity, as it provides insight into the level of interest and liquidity in a particular options contract.
- High open interest can suggest that a market is liquid and active.
- Low open interest can suggest that a market is illiquid or that traders are not interested in the underlying asset.
- Changes in open interest can provide insights into market sentiment and potential price movements.
Key Example of Open Interest:
Sure, here’s an example story of options trading with Tata Motors of how open interest works in practice:
Tata Motors, one of the largest automobile manufacturers in India, has been in the news recently due to a surge in its stock price. Let’s say we are tracking the open interest (OI) for its call and put options for five consecutive trading days.
Day 1:
- Activity: A trader buys 1000 Tata Motors call options with a strike price of 400 and a premium of 20.
- Open Interest: Call OI = 1000, Put OI = 0
- Change in OI: Call Change = +1000, Put Change = 0
Day 2:
- Activity: Two traders buy 500 Tata Motors put options each with a strike price of 380 and a premium of 15.
- Open Interest: Call OI = 1000, Put OI = 1000
- Change in OI: Call Change = 0, Put Change = +1000
Day 3:
- Activity: Three traders sell 200 Tata Motors call options each with a strike price of 420 and a premium of 25.
- Open Interest: Call OI = 800, Put OI = 1000
- Change in OI: Call Change = -200, Put Change = 0
Day 4:
- Activity: Four traders sell 300 Tata Motors put options each with a strike price of 360 and a premium of 10.
- Open Interest: Call OI = 800, Put OI = 700
- Change in OI: Call Change = 0, Put Change = -300
Day 5:
- Activity: Two traders buy 1000 Tata Motors call options each with a strike price of 440 and a premium of 30.
- Open Interest: Call OI = 1800, Put OI = 700
- Change in OI: Call Change = +1000, Put Change = 0
Here is the table with the above information provided:
| Day | Activity | Call OI | Put OI | Change in Call OI | Change in Put OI |
| 1 | A trader buys 1000 Tata Motors call options with a strike price of 400 and a premium of 20. | 1000 | 0 | +1000 | 0 |
| 2 | Two traders buy 500 Tata Motors put options each with a strike price of 380 and a premium of 15. | 1000 | 1000 | 0 | +1000 |
| 3 | Three traders sell 200 Tata Motors call options each with a strike price of 420 and a premium of 25. | 800 | 1000 | -200 | 0 |
| 4 | Four traders sell 300 Tata Motors put options each with a strike price of 360 and a premium of 10. | 800 | 700 | 0 | -300 |
| 5 | Two traders buy 1000 Tata Motors call options each with a strike price of 440 and a premium of 30. | 1800 | 700 | +1000 | 0 |
In this example, we can see that the call and put OI fluctuated over the five days depending on the buying and selling activity.
- The call OI increased on Day 1 and Day 5, while it decreased on Day 3 due to selling activity.
- The put OI increased on Day 2 due to buying activity and decreased on Day 4 due to selling activity.
Volume
Volume is another important metric that is closely related to open interest in the world of trading. It represents the total number of shares or contracts traded during a particular trading day or time period. It helps traders to gauge the level of interest and activity in a particular stock or market, and can be used in combination with open interest to form a more complete picture of market sentiment.
Here are some key points to keep in mind about volume and its relationship to open interest:
- Volume represents the total number of shares or contracts traded during a specific time period, such as a trading day, week, or month.
- Volume is often used as a measure of market liquidity and can indicate the level of interest and activity in a particular stock or market.
- Like open interest, volume can provide important insights into market sentiment and help traders to identify potential trends or shifts in direction.
- While volume and open interest are related, they represent different aspects of market activity. Open interest focuses on the number of outstanding contracts that have not yet been settled, while volume represents the total number of contracts that have been traded during a particular time period.
- In some cases, changes in volume can precede changes in open interest, indicating a potential shift in market sentiment. For example, if volume increases significantly but open interest remains stable, it could be a sign that traders are taking positions in anticipation of a future price movement.
- In other cases, changes in open interest may precede changes in volume, indicating that traders are taking positions in anticipation of future market activity. For example, if open interest in a particular stock or market begins to rise, it could be a sign that traders are anticipating a future price movement and taking positions accordingly.
- The relationship between volume and open interest can vary depending on market conditions and other factors. In some cases, high volume and high open interest can indicate a strong trend or momentum in a particular stock or market, while in other cases, they may suggest that traders are divided or uncertain about future market direction.
Key Example of Open Interest and Volume Comparison:
In the context of the previously shared example story of Tata Motors, Here is a table comparing volume and open interest:
| Volume | Open Interest | |
| Day 1 | 1000 | 1000 |
| Day 2 | 1000 | 2000 |
| Day 3 | 600 | 1400 |
| Day 4 | 800 | 600 |
| Day 5 | 2000 | 2600 |
- On Day 1, a trader bought 1000 call options, which increased the open interest by 1000 contracts.
- On Day 2, two traders bought 500 put options each, resulting in a total volume of 1000 contracts. However, since the contracts were bought from existing sellers, the open interest increased by only 1000 contracts, not 2000.
- On Day 3, three traders sold 200 call options each, resulting in a total volume of 600 contracts. This reduced the open interest by 200 contracts from the previous day.
- On Day 4, four traders sold 300 put options each, resulting in a total volume of 800 contracts. This reduced the open interest by 400 contracts from the previous day.
- On Day 5, two traders bought 1000 call options each, resulting in a total volume of 2000 contracts. Since these contracts were bought from existing sellers, the open interest increased by 1000 contracts.
Volume vs Open Interest:
While both open interest and volume are related to trading activity, they are different in their interpretation and significance.
| Metric | Volume | Open Interest |
| Definition | Total number of contracts traded in day | Total number of outstanding contracts in market |
| Time Frame | Usually Calculated for each trading day | Usually Changes are tracked across multiple days |
| Relevance | Volume is generally more relevant in all markets, including stocks, bonds, and commodities. | Open interest is generally more relevant in options and futures markets |
| Significance | Volume reflects the level of buying and selling activity in the market. | Open interest reflects the level of market activity. |
| Interpreting Change | Volume provides insights into the market’s direction and can help identify trends. A high volume but low open interest could mean the trades were primarily intraday trades | Open interest can give traders an idea of the level of participation in the market.
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