What is Open Interest? A Deep Dive for Futures & Options Traders
- What is Open Interest (OI)?
- How is Open Interest calculated?
- Understanding and interpreting OI trends
- How to perform Open Interest analysis effectively
Open Interest, commonly referred to as OI, serves as a critical indicator in the derivatives market. It reflects the total number of active and outstanding contracts in futures and options that are yet to be settled. Think of it as a measure of market participation and liquidity an essential insight for any trader using platforms like m.Stock.
Understanding Open Interest in the Derivatives Market
In the context of derivatives such as futures and options, Open Interest represents the total number of open contracts that are not yet squared off or exercised. These are contracts that remain active at the end of a trading session.
Importantly, OI only changes when a new contract is created. For instance, if Buyer B1 and Seller S1 initiate a new position, the OI goes up. However, if B1 sells this contract to Buyer B2, OI stays the same, as the contract is simply changing hands—not being newly formed or closed. Similarly, OI decreases only when a position is exited or closed, not when it is transferred.
OI vs Volume: A Crucial Distinction
Although trading volume and Open Interest are often mentioned together, they represent different metrics. Volume tracks the total number of contracts traded in a session new or existing. On the other hand, OI tracks only the newly created open positions. So, while volume gives an idea of activity, OI helps identify whether fresh positions are being added or removed from the market.
A rising OI indicates an inflow of capital and growing market participation. Conversely, a declining OI signals that traders are unwinding their positions, implying an outflow of capital.
Daily OI Change: A Window into Market Sentiment
Since OI is a cumulative figure, tracking its daily change offers better insights into short-term market behaviour. For example, if there are 100 existing contracts and just 1 new contract is added today, the total becomes 101. While the cumulative figure doesn't say much, the daily change (+1) highlights fresh activity and possible sentiment shifts.
Open Interest Analysis: What It Tells You
Open Interest isn’t just a number. It’s a powerful indicator used in technical and sentiment analysis. Many traders, especially on m.Stock, use OI changes to assess trend strength and reversals.
Trend Strength Through OI
A strong move, whether upward or downward, accompanied by a rise in OI is generally seen as confirmation of the trend. This suggests that new traders are entering positions, supporting the market's direction. In essence, fresh capital is flowing in, reinforcing the current sentiment.
Trend Reversals and Falling OI
In contrast, if a market is moving in a particular direction but OI starts to decline, it could be an early warning of a trend reversal. This implies that participants are exiting, and the trend may be losing steam. With fewer open positions, the likelihood of the trend continuing diminishes.
Using OI Data on Option Chains
On the National Stock Exchange (NSE), OI data is readily accessible via the Option Chain, which provides information for both Call and Put options. Since these are separate instruments, their OI figures are tracked independently.
Traders often analyze changes in OI on the Option Chain to gauge market moves. For example, a spike in call option OI at a specific strike price might indicate that option sellers, typically institutions or experienced traders, believe the price will not surpass that level. Hence, this level could act as a resistance zone.
Real-World Example
If a Call option at Strike Price 16,800 shows 89,974 contracts in OI, it suggests strong belief among option writers that NIFTY is unlikely to break past 16,800. Similarly, OI at psychological levels like 17,000 (1.19 lakh contracts) or 16,500 (1.46 lakh contracts) reinforces how these levels might serve as resistance or support zones.
Points to Remember
Open Interest reflects the total number of active derivative contracts.
OI increases only when new positions are added.
OI does not change when contracts are simply transferred between traders.
OI analysis is a critical tool for understanding market strength and sentiment.