Open Interest in Options Trading
Open interest provides an invaluable tool in figuring out where the derivatives market stands.
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Do you like uncertainty?
In a way, many of us do. It has an uncanny, inherent allure to it that can get your blood pumping—and seldom so much as when money is involved. However, there is a thin line between a risky, or even safe investment and gambling—and this difference lies in preparation. 💡
Considering how well the markets have been doing in the U.S. in 2021, this risk might seem negligible. However, considering that the Autumn of 2021 came heralding an extremely volatile future—especially stemming from the options markets—it is a good time to look at how best to prepare ourselves.
The derivatives markets are often considered more dangerous than equity trading as they are dependent on complex and future-dependent investment vehicles. However, they also boast tools that can help in mitigating this uncertainty.
These are mainly trading volume and open interest and, in this article, we’ll be taking a closer look at what open interest is, and how it can help you tell whether it truly is a bovine or an ursine market—and if it is really going to stay quite so bullish or bearish.
- What is Open Interest
- Volume vs. Open Interest
- Importance of Open Interest in Options Trading
- Reliability of Interest Information Feeds
- Open Interest FAQs
- Get Started with a Broker
What is Open Interest? 📝
Open interest is a metric mostly entwined with the options and futures markets. It tracks the number of open contracts on each day, as well as the day-to-day changes to these numbers. This metric is necessary since unlike the regular stock market which tends to have a stable and somewhat static number of shares available—options and futures can often be created and terminated at a whim.
More open interest is created when—for example—more options become available. So, let’s assume that on day zero there are no contracts and that on day 1 one becomes available. Let’s also assume that this trend is going to continue with more options contracts being created and sold over the following week and see how that would affect open interest.
| Day | Action | Open Interest |
|---|---|---|
| Day 1 | One contract is created | 1 |
| Day 2 | Five contracts are created | 6 |
| Day 3 | Four contracts are created and four are closed | 6 |
| Day 4 | Two contracts are created and three are closed | 5 |
| Day 5 | Four contracts are closed | 1 |
| Day 6 | Seven contracts are created and one is closed | 7 |
| Day 7 | Two contracts are created and eight are closed | 1 |
Open interest is calculated at the end of the day and is published at the beginning of the next. This is unlike volume, the other very important category, which gets updated multiple times per day.
Volume vs. Open Interest ⚖️
Volume and open interest represent the cornerstones of analyzing the derivatives market. Volume simply represents the number of contracts and shares traded in a certain period—a day in case of daily volume. Functionally, it is the same metric as stock volume—the difference being the market it measures.
This number is important as it indicates both the interest and liquidity of a certain security—which in turn tells you how likely you are to get rid of them in a pinch or at the most opportune time and how easy they are to come by when the price is good for buying.
Especially when trading futures and options, volume is relative and should always be compared to the underlying assets with no result guaranteeing an outcome. That being said, an increase in price accompanied with an increase in volume could indicate either a strong upward trend forming—but could also be a harbinger of a dangerous craze ushering in greater volatility.
Open interest similarly indicates both the state of the market and the strength of the current trends. The conclusions that can be drawn from this metric are also relative—they are viewed through a combined lens of open interest and price.
| Price | Open Interest | Possible Conclusion |
|---|---|---|
| Rising ↑ | Rising ↑ | Bullish market |
| Rising ↑ | Falling ↓ | Market is going to drop |
| Falling ↓ | Rising ↑ | Bearish market |
| Falling ↓ | Falling ↓ | Market is going to improve |
Since we mentioned temporary market crazes, we can look at the state of GME and the market in the late summer of 2021. Open interest for this company has been on a slight rise in this period, while their prices have been doing poorly after an early-September boost and have since suffered a sharp fall.
This, for example, indicates that the market isn’t doing terribly well, which at the time of looking at this data appears to be confirmed by the fact that investors were seemingly bracing for a weaker autumn of 2021.
Once again, unlike volume which determines the number of trades made in a day, open interest measures open positions—contracts that are waiting to be closed or exercised.
Why Open Interest is Important in Options Trading 📈
Considering that trading options and futures can be a risky business, every investor should reasonably seek every semblance of certainty they can muster. While simply looking at repeating patterns can be useful—like the now monthly mid-month weakening of the market coinciding with the expiry of options contracts—it simply isn’t enough. Open interest is a valuable tool in furthering this quest and its info comes in layers.
In its Own Right ☝️
Looked at on its own, open interest indicates liquidity. The higher the open interest is, the greater the liquidity. It also indicates the strength of the current trend. Once again, it means that if there is great open interest, the trend is strong, and vice-versa.
Expanding on this topic, high open interest indicates an active market with investors actively taking either long or short positions. Low open interest tells of a period of rest and holding—possibly in anticipation of a market top or bottom.
However, this metric alone doesn’t provide a full picture, and even combined with other factors like price and volume it doesn’t give the investors all the info they need as it tends not to say whether the contracts are puts or calls.
| High Open Interest | Low Open Interest |
|---|---|
| Investors are actively taking long or short positions | Investors are holding and biding their time |
A Combined Effort 🤝
On the other hand, when you combine this metric with the price, a more complete image of the future emerges. When both the prices and open interest are rising, the market tends to be bullish as investors are eager to get in on the action.
Rising open interest and falling prices speak of a lack of confidence and a possible bearish market with investors trying to stay on top by taking short positions. Similarly, high prices and low open interest allude to a different lack of certainty—investors are fearing the end of a bull market.
Low prices combined with low open interest indicate a coming reversal of the trend of another kind—the market might hit the bottom and the end of a bear market might be on the horizon. A similar insight can be gathered from rather static open interest rates. If combined with high prices a market top could be near, and when the prices are low, the bottom might be coming.
| Prices | Open interest | The market is | The trend is |
|---|---|---|---|
| High | High | Bullish | Strong |
| High | Low | Bullish | About to stop |
| High | Static | Bullish | Market top is impending |
| Low | High | Bearish | Strong |
| Low | Low | Bearish | About to stop |
| Low | Static | Bearish | Market bottom is impending |
The unfortunate fact that the nature of trades made isn’t transparent with open interest makes many investors reluctant to even look at this metric. However, they are certainly not to be ignored as even data simply indicating the state of the market and its current trend can greatly help you come up with an options trading strategy.
Furthermore, it is certainly highly useful to have some insight into when a bull market might be coming to an end, or when the market will shake off a downtrend like the one that was pressuring it towards September of 2021.
Are Open Interest Information Feeds Reliable? ❓
Open interest feeds tend to be reliable with the aforementioned caveat that they are updated at the end of a trading day. This means while the data is correct at the time of collection, it might have become obsolete by the time you get your hands on it.
However, this should be a non-issue under most circumstances for it would take extreme volatility to make the data from the feed truly unreliable.
While there are numerous places you can find information on current open interest, it is probably best to go to an official source like the Options Price Reporting Authority (OPRA) website for the U.S.
Additionally, other countries with major stock exchanges tend to have their centralized authorities on options and other derivatives markets. Furthermore, in the U.S., NASDAQ has its own open interest feed.
However, you should note that most of the most in-depth open interest charts are hidden behind a paywall with most free charts offering either only the most recent data, or data only encompassing the biggest changes in this metric.
Fortunately, all of the leading brokers for options trading tend to come with their own analytics and metrics which can greatly help you determine which derivatives to trade without having to fork cash over to a myriad of other websites and services.
Conclusion ✍️
Considering the overall good state of the market over the recent period, even despite the pandemic, you might be very eager to get into options and futures trading. Furthermore, since the number of quality discount brokers seems to be ever-rising, you might have an even greater incentive.
However, as we’ve seen the market can be very bullish despite the circumstances such as the covid-19 pandemic—and those periods can end abruptly as evidenced by many more-or-less unexpected downturns like the difficult-to-shake decline that happened in September 2021. It is unwise to go simply on semi-informed logic and even less informed media reporting, doubly so when there are at least mostly reliable indicators like open interest available to the investors.
Open Interest FAQs
-
Where Do You Find Open Interest Data?
While you could find open interest data in a variety of sources, the most reliable info tends to be on official websites like OPRA and NASDAQ. The National stock exchange (NSE) is often cited online as a reliable site, and it is, though you should note that NSE is the National stock exchange of India. When looking at this data you should be mindful that it is updated at the closing of the trading day, so at any given time you’ll be looking at yesterday’s numbers.
-
How Do You Calculate Open Interest?
Open interest is calculated rather simply—you take the number of contracts opened and subtract from it the number of closed contracts. This number can vary significantly as contracts can be created or removed freely. However, this doesn’t mean that this metric isn’t important as it—alongside volume—gives valuable insight into the liquidity and desirability of an option or a future. It can also help indicate coming market trends.
-
What Happens When Open Interest Increases?
Generally speaking, an increase in open interest tends to indicate a confirmation of an existing trend. If paired with rising prices it reinforces that the market is strong, and combined with dropping prices it hints at a weak market. Conversely, a decrease in open interest can herald a reversal of a trend.
-
Is Open Interest a Good Indicator?
Open interest is a decent indicator of either the stability of a market trend or its coming reversal. That being said, one should never rely solely on open interest—or any other singular indicator—when making financial decisions. For example, open interest is often combined with trading volume to provide a more complete picture.
-
What Does Open Interest Indicate?
Open interest identifies and measures the number of available contracts for options or futures. It also tracks the change in their availability from day to day calculating these shifts at the end of a trading day.
-
What is Open Interest Restriction?
Open interest restriction, also termed open interest limit refers to the market-wide limit to certain security. This limit can’t be exceeded without triggering penalties and tends to be around 5% for clients and 15% for brokers.
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All reviews, research, news and assessments of any kind on The Tokenist are compiled using a strict editorial review process by our editorial team. Neither our writers nor our editors receive direct compensation of any kind to publish information on tokenist.com. Our company, Tokenist Media LLC, is community supported and may receive a small commission when you purchase products or services through links on our website. Click here for a full list of our partners and an in-depth explanation on how we get paid.
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