What is Open Interest ?
Open Interest is the total number of outstanding contracts that are held
by market participants at the end of the day.
It can also be defined as the total number of futures contracts or option contracts that have not yet been exercised (squared off), expired, or fulfilled by delivery.
Open interest applies primarily to the futures market. Open interest, or the total number of open contracts on a security, is often used to confirm trends and trend reversals for futures and options contracts.
Open interest measures the flow of money into the futures market. For each seller of a futures contract there must be a buyer of that contract. Thus a seller and a buyer combine to create only one contract.
Therefore, to determine the total open interest for any given market we need only to know the totals from one side or the other, buyers or sellers, not the sum of both.
The open interest position that is reported each day represents the increase or decrease in the number of contracts for that day, and it is shown as a positive or negative number.
How to calculate Open Interest
Each trade completed on the exchange has an impact upon the level of open interest for that day.
For example, if both parties to the trade are initiating a new position ( one new buyer and one new seller), open interest will increase by one contract.
If both traders are closing an existing or old position ( one old buyer and one old seller) open interest will decline by one contract.
The third and final possibility is one old trader passing off his position to a new trader ( one old buyer sells to one new buyer). In this case the open interest will not change.
Benefits of monitoring open interest
By monitoring the changes in the open interest figures at the end of each trading day, some conclusions about the day’s activity can be drawn.
Increasing open interest means that new money is flowing into the marketplace. The result will be that the present trend ( up, down or sideways) will continue.
Declining open interest means that the market is liquidating and implies that the prevailing price trend is coming to an end. A knowledge of open interest can prove useful toward the end of major market moves.
A leveling off of open interest following a sustained price advance is often an early warning of the end to an uptrending or bull market.
Open Interest - A confirming indicator
An increase in open interest along with an increase in price is said to confirm an upward trend. Similarly, an increase in open interest along with a decrease in price confirms a downward trend. An increase or decrease in prices while open interest remains flat or declining may indicate a possible trend reversal.
The relationship between the prevailing price trend and open interest can be summarized by the following table.
It can also be defined as the total number of futures contracts or option contracts that have not yet been exercised (squared off), expired, or fulfilled by delivery.
Open interest applies primarily to the futures market. Open interest, or the total number of open contracts on a security, is often used to confirm trends and trend reversals for futures and options contracts.
Open interest measures the flow of money into the futures market. For each seller of a futures contract there must be a buyer of that contract. Thus a seller and a buyer combine to create only one contract.
Therefore, to determine the total open interest for any given market we need only to know the totals from one side or the other, buyers or sellers, not the sum of both.
The open interest position that is reported each day represents the increase or decrease in the number of contracts for that day, and it is shown as a positive or negative number.
How to calculate Open Interest
Each trade completed on the exchange has an impact upon the level of open interest for that day.
For example, if both parties to the trade are initiating a new position ( one new buyer and one new seller), open interest will increase by one contract.
If both traders are closing an existing or old position ( one old buyer and one old seller) open interest will decline by one contract.
The third and final possibility is one old trader passing off his position to a new trader ( one old buyer sells to one new buyer). In this case the open interest will not change.
Benefits of monitoring open interest
By monitoring the changes in the open interest figures at the end of each trading day, some conclusions about the day’s activity can be drawn.
Increasing open interest means that new money is flowing into the marketplace. The result will be that the present trend ( up, down or sideways) will continue.
Declining open interest means that the market is liquidating and implies that the prevailing price trend is coming to an end. A knowledge of open interest can prove useful toward the end of major market moves.
A leveling off of open interest following a sustained price advance is often an early warning of the end to an uptrending or bull market.
Open Interest - A confirming indicator
An increase in open interest along with an increase in price is said to confirm an upward trend. Similarly, an increase in open interest along with a decrease in price confirms a downward trend. An increase or decrease in prices while open interest remains flat or declining may indicate a possible trend reversal.
The relationship between the prevailing price trend and open interest can be summarized by the following table.
|
Price
|
Open Interest
|
Interpretation
|
|
Rising
|
Rising
|
Market is Strong
|
|
Rising
|
Falling
|
Market is Weakening
|
|
Falling
|
Rising
|
Market is Weak
|
|
Falling
|
Falling
|
Market is Strengthening
|
More Explanation :-
If another trader A buys 2 futures contracts from trader B, then
the open interest rises to 4. Now, if trader X unwinds his position and the counterparty is either Y or B, then the open interest in the system will
reduce by that quantity.
But if X unwinds his position,
and the counter party is a new entrant, say C, then the open interest will
remain unchanged. This is because while X has squared off his position, C's
position is still open. The level of outstanding positions in the derivatives
segment is one of the parameters widely tracked by the market.
How can one interpret open
interest data?
While open interest shows the
total number of outstanding contracts, the data is not much of use, if looked
at on a standalone basis. In the futures segment, open interest data need to be
read along with price changes in the futures contract.
A rise in open interest in a
futures contract along with its price indicates bullishness, which means
investors are creating long positions. Investors may benchmark the price changes
in the futures contract to the underlying (the cash market).
For instance, on Monday, if
Nifty futures closes at 3000 and S&P Nifty at 3025, then it is said Nifty
futures are trading at a 25-point discount to the cash market index. Let's
assume that open interest in the Nifty futures contract on Monday was 1 crore
units. Now, on Tuesday, if Nifty futures closes at 3050, S&P Nifty at 3060
(discount reduces to 10 points) and open interest rises to 1.25 crore, then it
means, investors have created long positions.
In another scenario, if open
interest in the contract rises, but price falls, then it indicates that
investors are cautious or bearish. In short, investors are creating short
positions. Now, in case open interest in the futures contract falls, but its
price moves up, it indicates a bullish trend. This situation is a result of
covering of short positions. In another scenario where there is a fall in open
interest and price too, analysts read it as a bearish signal, as investors are
liquidating their long positions .
The above example can be used
in these scenarios too. In the options segment, a change in open interest in
put or call options enables traders calculate the put call ratio (PCR) — a
popular sentiment indicators of options traders worldwide, which is the number
of puts divided by the number of calls.
Is open interest the same as
trading volumes?
Open interest should not be
mistaken for volumes, which is the total number of contracts that have been
traded in a trading session. Higher the number of trades in a session, more
will the volumes swell, unlike open interest, which drops if a contract is
liquidated. Usually, traders use volumes data along with open interest data and
prices to derive a more concrete view on the market.
