What is Open Interest (OI) and How to Analyse it?

Open interest is an indicator used in the futures and options segment of the share market. Traders and investors closely monitor OI data to understand the market sentiment, identify support and resistance levels, and predict price movements.

In India, traders use OI data, open interest charts, and the put-call ratio to interpret derivatives data. It allows traders to monitor changes in positions and identify whether fresh money is entering or exiting the market.

This article discusses the concept of open interest, how it works, its interpretation, and significance.

What is Open Interest?

Open Interest refers to the total number of outstanding futures or option contracts that are currently active in the market. These contracts have not been squared off, expired, or exercised.

In simple terms, open interest represents the number of active market positions held by buyers and sellers at a given time.

For example, if one trader buys one option contract and another trader sells the same contract, one open interest is created. If both traders later close their positions, the open interest decreases.

Open interest is commonly displayed in the option chain along with strike prices, premiums, and trading volumes.

How does Open Interest work?

Open interest changes whenever new positions are created or existing positions are closed. Every trade in the derivatives market involves both a buyer and a seller, but OI changes depending on whether the transaction creates a new position or closes an old one.

When fresh positions are created by both buyer and seller, open Interest increases. When both parties close existing positions, open Interest decreases.

Situations Affecting Open Interest

Here are the situations that directly affect the open interest in futures and options.

• Fresh Buying and Selling:

When both traders create new positions, open interest increases because new contracts enter the market.

• Position Closure:

When both parties square off existing positions, open interest decreases due to contract removal.

• Transfer of Positions:

If one trader exits and another trader enters, open interest remains unchanged because the total active contracts stay constant.

• Expiry Settlement:

Open interest automatically declines near expiry as contracts are settled or closed by traders.

Example of Open Interest

Suppose Trader A buys 5 Nifty option contracts from Trader B. Since both traders have created fresh positions, the open interest increases by 5 contracts.

Now, Trader A sells those 5 contracts to Trader C. If Trader A exits and Trader C enters, open interest remains unchanged.

Later, if Trader B and Trader C close their positions completely, open interest decreases by 5 contracts.

This is how OI Data changes depending on the creation and closure of derivative contracts.

What happens when OI increases?

An increase in open interest (OI) generally indicates that new money is entering the market. Traders interpret rising OI as a sign of stronger market participation and trend continuation.

However, OI should always be analysed together with price movement for accurate interpretation.

Price Up and OI Up

When the price is up, and OI is also up, this is what it indicates.

• Bullish Confirmation:

Rising prices along with an increase in open interest indicate strong bullish sentiment and fresh long position creation.

• Trend Strength:

Higher OI during price rise confirms strong buying activity and continuation of upward market momentum.

Price Down and OI Up

When the price is down, and OI is up, this is what it indicates.

• Bearish Confirmation:

Falling prices with rising Open Interest indicate aggressive short selling and bearish market sentiment among traders.

• Short Build-up:

Increase in Open Interest during market decline signals fresh short positions entering the derivatives market.

What happens when OI decreases?

A decrease in open interest indicates that traders are closing positions and money is exiting the market. Falling OI often suggests weakening momentum or trend reversal possibilities.

Price Up and OI Down

When the price is up, and open interest is down, this is what it indicates.

• Short Covering Rally:

Rising prices with falling open interest indicate short covering instead of fresh bullish position creation.

• Temporary Momentum:

Price rise caused by short covering may not sustain for long without fresh buying participation.

Price Down and OI Down

When the price is down, and open interest is also down, this is what it indicates.

• Long Unwinding:

Falling prices, along with decreasing open interest, indicate the liquidation of existing long positions by traders.

• Weak Market Sentiment:

Declining OI and falling prices often reflect reduced confidence and lower market participation.

Significance of Open Interest Data

Here are the main importance of open interest (OI) data.

• Market Sentiment Analysis:

OI Data helps traders identify bullish or bearish positioning in the derivatives market effectively.

• Support Resistance Levels:

Traders use Option Chain open interest to determine important market support and resistance zones.

• Trend Confirmation:

Rising Open Interest validates ongoing trends and improves confidence in trade execution decisions.

• Liquidity Measurement:

Higher open interest contracts usually offer smoother trade execution with minimal slippage risk.

• Institutional Activity Tracking:

Large changes in open interest may indicate participation by institutional traders and market operators.

• Expiry Analysis:

Traders monitor NSE open interest data during expiry weeks to analyse potential market movement and volatility.

Difference Between Open Interest and Trading Volume

Here is the difference between open interest and trading volume in the option chain.

How to use open interest in intraday trading?

Intraday traders use open interest charts along with price action and technical analysis for decisions. Monitoring real-time OI data helps traders to identify momentum shifts and possible reversals.

Intraday Open Interest Strategies

Here are the common intraday open interest strategies used by traders.

• OI Breakout Strategy:

A sudden increase in open interest with a price breakout indicates strong trend continuation possibilities during intraday sessions.

• Support Resistance Analysis:

Maximum Put OI is generally considered a support level, while maximum Call OI acts as resistance in intraday trading.

• Long Build-up Identification:

Rising prices along with increasing OI indicate fresh buying opportunities for bullish intraday traders.

• Short Build-up Identification:

Falling prices along with rising OI indicate fresh short-selling opportunities in the market.

• Short Covering Detection:

A price rise accompanied by declining OI indicates short covering rallies during volatile market conditions.

• Long Unwinding Detection:

Falling prices, along with decreasing OI, indicate traders exiting long positions aggressively.

• Expiry Day Analysis:

Traders monitor rapid changes in open interest during expiry sessions to identify quick trading opportunities.