Open interest (OI) is a key indicator in options trading. It is the total number of open options contracts on a stock or index. This number changes throughout the day as traders buy and sell contracts. It is an important indicator to watch as it measures whether an underlying asset is trending up, down or sideways.
1. Open interest is the total number of contracts that are currently open in the market. Every buyer and seller in the market creates a new contract, and when these contracts remain open, they contribute to open interest.
2. However, open interest is not the same as volume. Volume refers to the total number of shares or contracts traded during a given period, while open interest shows the total number of contracts outstanding. It is important to note that volume applies to both equities and derivatives segments, while OI only applies to derivatives.
3. Change in open interest can reflect shifts in market sentiment. An increase in open interest at any other strike means that new contracts are being created. Conversely, a decrease in open interest may indicate that traders are closing out the contract they previously held. In a nutshell, monitoring change in open interest can help make more informed trading decisions.
4. How do you use it? Open interest combined with price data helps to gauge market sentiment for an option contract. For example, if open interest is increasing along with the price, it is a sign of a bullish trend. Conversely, if the price is falling and open interest is rising, it is a sign of a bearish trend.
5. Use open interest to decide when to enter or exit a trade. You can do so by using OI to identify support and resistance levels for a stock or index. Also confirm the support and resistance levels on the price chart.
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Want to learn how to frame a trading strategy based on open interest? Click here to read a chapter that explains all about Open interest from our Options Book. Get a deeper understanding of the concept and how it can help you navigate the markets effectively.