Open Interest
Open Interest also know as OI, is the total number of options and futures contracts that are not closed on a particular day.
It can also be defined as the total number of futures contracts or option contracts that have not yet been exercised (squared off), expired, or fulfilled by delivery.
How to calculate Open Interest
For example, if three traders (trader A, trader B, and trader C) are all trading the
Trader B enters a long trade by buying four contracts
Open interest increases to 5
Trader A exits their trade by selling one contract
Open interest decreases to 4
Trader C enters a short trade by selling four contracts
Open interest increases to 8
Open interest is not the same as volume. With volume, both entries and exits cause volume to increase, but with open interest, entries cause open interest to increase, while exits cause open interest to decrease.
Thus each trade completed on the exchange has an impact upon the level of open interest for that day.
1. if both parties to the trade are initiating a new position ( one new buyer and one new seller), open interest will increase by one contract.
2. If both traders are closing an existing or old position ( one old buyer and one old seller) open interest will decline by one contract.
3. The final possibility is one old trader passing off his position to a new trader ( one old buyer sells to one new buyer). In this case the open interest will not change.
How does it work
When a trader buy’s or sell’s an option, the transaction needs to be entered as either an opening or a closing transaction. If he buy’s 5 RELIANCE May 1000 CALL, he is buying the calls to ‘open’, i.e he is opening his position in a futures contract, which causes the Open interest to rise by 5, and then after sometime(within) the month he decides to sell his contract i.e close his position in a particular contract, then he is causing the open interest to go down by 5.
Open interest applies primarily to the futures market, it helps the measure the flow of money into the futures Market. For each seller of a futures contract (eg RELIANCE 1000 CALL) there must be a buyer of that contract. Thus a seller and a buyer combine to create only one contract.
A rise in open interest in a futures contract along with its price indicates bullishness, which means investors are creating long positions and vice versa.
The open interest position that is reported each day represents the increase or decrease in the number of contracts for that day, and it is shown as a positive or negative number.
Benefits of monitoring open interest
By monitoring the changes in the open interest figures at the end of each trading day, some conclusions about the day’s activity can be drawn.
The open interest position that is reported each day represents the increase or decrease in the number of contracts for that day, and it is shown as a positive or negative number
##Increasing open interest means that new money is flowing into the marketplace. The result will be that the present trend ( up, down or sideways) will continue.
##Declining open interest means that the market is liquidating and implies that the prevailing price trend is coming to an end. A knowledge of open interest can prove useful toward the end of major market moves.
##A leveling off of open interest following a sustained price advance is often an early warning of the end to an uptrending or bull market.
Open Interest - A confirming indicator
An increase in open interest along with an increase in price is said to confirm an upward trend. Similarly, an increase in open interest along with a decrease in price confirms a downward trend. An increase or decrease in prices while open interest remains flat or declining may indicate a possible trend reversal.
The relationship between the prevailing price trend and open interest can be summarized by the following table.
Price Open Interest Interpretation
Rising Rising Market is Strong
Rising Falling Market is Weakening
Falling Rising Market is Weak
Falling Falling Market is Strengthening
Premium and Discount
when there is up trend,futures are sold at price higher than actual derivative price ( eg spot nifty)and similarly when there is down trend ,futures are sold at price lesser than derivative price.this price difference is called premium and discount.
