Open Interest is the total number of outstanding contracts position that are held by traders, investors as buyer or seller which are not yet executed during a given period of time. Open interest is most often used as an indication of the strength behind the market, but is not the same as volume. A common misconception is that open interest is the same thing as volume of options and futures trades.
Open interest is calculated by adding all of the contracts that are associated with opening trades and subtracting all of the contracts that are associated with closing trades. Try to understand the concept with below explained table:-
|A buys 1 option and B sells 1 option contract
|C buys 5 option and D sells 5 option contracts
|A sells his 1 option and D buys 1 option contract
|E buys 5 options from C who sells 5 options contracts
- On January 1, A buys an option, which leaves an open interest and also creates trading volume of 1.
- On January 2, C and D create trading volume of 5 and there are also five more options left open.
- On January 3, A takes an offsetting position, open interest is reduced by 1 and trading volume is 1.
- On January 4, E simply replaces C and open interest does not change, trading volume increases by 5.
Open interest can be used as an authentication tool to categorize whilst a trend might be coming at the point of termination or if the trend is sustainable by new money coming into the market. There must be a seller for every buyer of a Futures contract. What we will be looking for from open interest is will there be new buying or selling coming into a market to support the continuation of the current trend?
So by now we have realized the open interest acts trend identification for the stock price movement. When determining open interest of any given Futures market, we need only to know the totals from one side or the other, buyers or sellers, not the total of both. Therefore, the number we see posted as OI is the actual number of outstanding Futures contracts and not the number of market participants. But when we see the open interest in running market or intraday market we may not get the real picture of the market as the real number about open interest can only be ascertained at the end of the trading session.
Effect of Volume & OI on Price
Volume and Open Interest for GBP-INR Currency Futures
An increasing open interest means that the new money is flowing in the marketplace and the present trend will continue. If the open interest is declining it implies that the market is liquidating and the prevailing price trend is coming to an end. The leveling off of open interest following a sustained price advance is often an early warning of the end to an up trending or bull market.
|Market Weakening/ Longs Unwinding
|Market is Weak
|Market is Strengthening/Short Covering