Open Interest

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker 2020!
    Perfect For Beginners!
    Free Demo Account!
    Free Trading Education!
    Get Your Sign-Up Bonus Now!

  • Binomo
    Binomo

    Good Choice For Experienced Traders! 2nd place in the ranking!

Open Interest

What Is Open Interest?

Open interest is the total number of outstanding derivative contracts, such as options or futures that have not been settled for an asset. The total open interest does not count, and total every buy and sell contract. Instead, open interest provides a more accurate picture of the options trading activity, and whether money flows into the futures and options market are increasing or decreasing.

Open Interest

Open Interest Explained

To understand open interest, we must first explore how options and futures contracts are created. If an options contract exists, it must have had a buyer. For every buyer, there must be a seller since you cannot buy something that is not available for sale.

The relationship between the buyer and seller creates one contract, and a single contract equates to 100 shares of the underlying asset. The contract is considered “open” until the counterparty closes it. Adding up the open contracts, where there are a buyer and seller for each, results in the open interest.

If a buyer and seller come together and initiate a new position of one contract, then open interest will increase by one contract. Should a buyer and seller both exit a one contract position on a trade, then open interest decreases by one contract. However, if a buyer or seller passes off their current position to a new buyer or seller, then open interest remains unchanged.

Key Takeaways

  • Open interest is the total number of outstanding derivative contracts, such as options or futures that have not been settled.
  • Open interest equals the total number of bought or sold contracts, not the total of both added together.
  • Open interest is commonly associated with the futures and options markets.
  • Increasing open interest represents new or additional money coming into the market while decreasing open interest indicates money flowing out of the market.

Changes to Open Interest

It’s important to note that open interest equals the total number of contracts, not the total of each transaction by every buyer and seller. In other words, open interest is the total of all the buys or all of the sells, not both.

The open interest number only changes when a new buyer and seller enter the market, creating a new contract, or when a buyer and seller meet—thereby closing both positions. For example, if one trader has ten contracts short (sale) and another has ten contracts long (purchase), and these traders then buy and sell ten contracts to each other, those contracts are now closed and will be deducted from open interest.

Open interest is commonly associated with the futures and options markets, where the number of existing contracts changes from day to day. These markets differ from the stock market, where the outstanding shares of a company’s stock remain constant once a stock issuance has been completed.

A common misconception of open interest lies in its purported predictive ability. It cannot forecast price action. High or low open interest reflects investor interest, but it does not mean that their views are correct or their positions will be profitable.

Open Interest vs. Trading Volume

Open interest is sometimes confused with trading volume, but the two terms refer to different measures. On a day when one trader who already holds 10 option contracts sells those 10 contracts to a new trader entering the market, the transfer of contracts does not create any change in the open interest figure for that particular option.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker 2020!
    Perfect For Beginners!
    Free Demo Account!
    Free Trading Education!
    Get Your Sign-Up Bonus Now!

  • Binomo
    Binomo

    Good Choice For Experienced Traders! 2nd place in the ranking!

No new option contracts have been added to the market because one trader is transferring their position to another. However, the sale of the 10 option contracts by an existing option holder to an option buyer does increase the trading volume figure for the day by 10 contracts.

The Importance of Open Interest

Open interest is a measure of market activity. Little or no open interest means there are no opening positions, or nearly all the positions have been closed. High open interest means there are many contracts still open, which means market participants will be watching that market closely.

Open interest is a measure of the flow of money into a futures or options market. Increasing open interest represents new or additional money coming into the market while decreasing open interest indicates money flowing out of the market.

Open Interest and Trend Strength

Open interest is also used as an indicator of trend strength. Since rising open interest represents additional money and interest coming into a market, it is generally interpreted to be an indication that the existing market trend is gaining momentum or is likely to continue.

For example, if the trend is rising for the price of the underlying asset such as a stock, increasing open interest tends to favor a continuation of that trend. The same concept applies to downtrends. When the stock price is declining, and open interest is increasing, open interest supports further price declines.

Many technical analysts believe that knowledge of open interest can provide useful information about the market. For example, if there is a deceleration in open interest following a sustained move—either up or down—in price, then it might be foreshadowing an end to that trend.

Real World Example of Open Interest

Below is a table of trading activity in the options market for traders, A, B, C, D, and E. Open interest is calculated following the trading activity for each day.

Open Interest vs. Volume: What’s the Difference?

Open Interest vs. Volume: An Overview

Volume and open interest are two key measures that describe the liquidity and activity of contracts in the options and futures markets. However, their meanings and applications are different. Volume refers to the number of contracts traded in a given period, while open interest denotes the number of contracts that are open or active. Here’s a more detailed look at the two measures and how investors can use them to understand trading activity in the derivatives markets better.

Volume

Trading volume is updated throughout the trading day and measures the number of options or futures contracts being exchanged between buyers and sellers, identifying the level of activity for that particular contract. For every option that is bought and sold, the transaction itself counts toward the daily volume, regardless if the trade is an opening or closing transaction.

Key Takeaways

  • Volume and open interest both describe the liquidity and activity level of contracts in the options and futures markets.
  • Volume refers to the number of trades completed and is, therefore, a key measure of strength and interest in a particular trade.
  • Open interest reflects the number of contracts that are held by traders and investors in active positions, ready to be traded.
  • While volume is running total throughout the trading day, open interest is updated just once per day.

For example, assume the volume in call option ABC with a strike price of $55 and an expiration date in three weeks did not trade any contracts on a specified day. Therefore, the trading volume is 0. In the next session, an investor buys 15 call option contracts, and there are no other trades that day, the volume is now 15 contracts.

Investors sometimes see volume as an indicator of the strength of a price move. The higher the volume, the more interest there is in the security. The higher volume also means that there is greater liquidity in the contract, which is desirable from a short-term trading perspective, as it means there is an abundance of buyers and sellers in the market.

Open Interest

Open interest is the number of options or futures contracts that are held by traders and investors in active positions. These positions have been opened (either buy or sell) not been closed out, expired, or exercised. Open interest, which is updated just once per day, decreases when buyers (or holders) and sellers (or writers) of options (or buyers and sellers of futures) close out more positions than were opened that day.

To close out positions, a trader must take offsetting positions or exercise their options. Open interest increases once again when investors and traders open more new long positions or writers/sellers take on new short positions in an amount greater than the number of contracts that were closed that day.

For example, assume the open interest of the ABC call option is 0. The next day an investor buys 10 options contracts as a new position. Open interest for this particular call option is now 10. The day after, five contracts were closed, 10 were opened, and open interest increases by five to 15.

Volume and open interest are sometimes used in technical analysis, as the numbers provide information about the buying or selling interest underlying a potential price move. However, one must also look further at whether the open interest is in calls or puts, and whether the contracts are being bought or sold.

Special Considerations

1. Rising prices in an uptrend while open interest is on the rise indicates that new money is coming into the market (reflecting new positions). This can be considered a sign of bullish sentiment if the increase in open interest is being fueled by buying or long positions.

2. Rising prices in an uptrend while open interest is on the decline could indicate that money is leaving the marketplace; this is a bearish sign.

3. Falling prices in a downtrend while open interest is on the rise might suggest that new money is coming into the market on the short side. This scenario is consistent with a downtrend continuation and is bearish.

4. Falling prices in a downtrend while open interest is on the decline possibly indicates that disgruntled holders are forced to liquidate positions and is a bearish sign. However, it can also indicate that a selling climax is near.

5. High open interest while prices drop sharply at a potential market top could be a bearish scenario if holders who bought near the top are now losing money, raising the potential for panic selling.

How to Calculate Interest

Updated: March 29, 2020 | References

This article was co-authored by our trained team of editors and researchers who validated it for accuracy and comprehensiveness. Together, they cited information from 12 references.

wikiHow’s Content Management Team carefully monitors the work from our editorial staff to ensure that each article meets our high quality standards. Learn more.

Most people are aware of the concept of interest, but not everyone knows how to calculate it. Interest is the value that we add to a loan or a deposit to pay for the benefit of using someone else’s money over time. Interest can be calculated in three basic ways. Simple interest is the easiest calculation, generally for short term loans. Compound interest is a bit more complicated and a bit more valuable. Finally, continuously compounding interest grows at the fastest rate and is the formula that most banks use for mortgage loans. The information you need for any of these calculations is generally the same, but the math is a bit different for each.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker 2020!
    Perfect For Beginners!
    Free Demo Account!
    Free Trading Education!
    Get Your Sign-Up Bonus Now!

  • Binomo
    Binomo

    Good Choice For Experienced Traders! 2nd place in the ranking!

Like this post? Please share to your friends:
Guide How To Become Binary Options Trader
Leave a Reply

;-) :| :x :twisted: :smile: :shock: :sad: :roll: :razz: :oops: :o :mrgreen: :lol: :idea: :grin: :evil: :cry: :cool: :arrow: :???: :?: :!: