Table of contents
Introduction
“Open Interest” is a term you may hear in Futures and Options (F&O) trading. It is like a snapshot of ongoing trades, showing the number of futures and options contracts that are still active, not closed, exercised, or expired. Open interest gives a peek into the market’s overall direction.
This article breaks down what is open interest in the stock market, focusing on futures and options. So let’s get started.
What is open interest?
Open Interest is a fundamental concept in the stock market. It refers to the total number of outstanding contracts for a particular financial instrument, such as options or futures.
In other words, open interest describes the total number of contracts in the market that haven’t been settled. Unlike trading volume, which counts how many contracts are traded in a day, open interest counts how many contracts are still open or active.
For example, if traders buy and sell 100 contracts in a day, the trading volume is 100. However, if 20 of these contracts are still open at the end of the day and not closed, then the open interest is 20.
This number is useful for traders because it gives them an idea of how much interest is there in an instrument. A high open interest indicates that there is a high interest from traders in that market, which could mean that the market is active and could have significant price movements. On the other hand, a low open interest suggests less activity or interest.
How is open interest calculated?
Now you know what is option interest, let’s see how it’s calculated. Open interest isn’t about the number of transactions but rather the number of contracts that are still ‘open’ or unsettled in the market.
Let’s use an example to make this clearer:
- Imagine a market where only two traders, let’s call them Neha and Ram, are trading NIFTY 50 futures. On Monday, Neha buys 1 NIFTY 50 futures contract, and Ram sells 1 contract. Since both are initiating a new position (Neha is long, and Ram is short), Open Interest increases by 1, making the total NIFTY 50 open interest 1.
- Now, let’s say on Tuesday, a third trader, Swastik, enters the market. Swastik buys 2 NIFTY 50 futures contracts from Ram, who already has a short position. Here, only Swastik is initiating a new position, while Ram is just adjusting his existing one. This adds 2 more contracts to the Open Interest, making the total NIFTY 50 open interest 3.
- On Wednesday, Neha decided to sell her 1 contract to a new trader, David, who’s entering the market for the first time. In this case, no new contract is created; it’s just transferred from Neha to David. So, the NIFTY 50 open interest remains at 3.
- Finally, on Thursday, let’s say Swastik decides to close his position by selling his 2 contracts to Ram. Both are closing their positions, so the open interest decreases by 2, leaving the total NIFTY 50 open interest at 1.
To sum up, open interest is the total number of active contracts in the market. It increases when new contracts are created and decreases when contracts are closed. By tracking changes in open interest, you can gauge market sentiment – whether traders are building positions (bullish sign) or unwinding them (bearish sign).
Remember, this is a simplified example to illustrate the concept. In real markets, hundreds or thousands of transactions can occur, making open interest a dynamic and significant market indicator. Understanding its nuances will help you make more informed trading decisions.
Interpreting open interest and its market implications
While monitoring open interest alone may not reveal significant information, its relation with price movement and volume needs to be considered.
| Contract price | Volume | Open price | Future trend (Interpretation) |
| Rising | Rising | Rising | Expect the ongoing bullish trend to persist in the upcoming days. Traders are advised to maintain their existing positions or consider initiating new positions on the long side of the contract. |
| Rising | Falling | Falling | The ongoing bullish trend is anticipated to reach its peak soon, possibly followed by a period of sideways movement or a potential downtrend in the upcoming days. Traders are advised to consider booking profits or exiting their long future contracts at this point. |
| Falling | Falling | Falling | The current bearish trend might be short-lived, paving the way for potential sideways or upward movements in the near future. Traders may consider closing their existing short positions and cautiously transitioning towards long positions in the script’s future contract. |
| Falling | Rising | Rising | The ongoing bearish trend is anticipated to persist. Traders may consider maintaining their existing short positions or opt to initiate new short positions in the future contract of the script. |
When observing the above table, an increase in open interest suggests a likelihood of continuing the current trend (whether it’s an uptrend, downtrend, or a flat market). Conversely, a decrease in open interest indicates a potential shift or conclusion of the present trend.
Unlike trading volumes, changes in open interest don’t provide a clear indication of market direction. However, they do offer insights into the strength of either a bullish or bearish trend.
When there’s a sudden increase in open interest, accompanied by a rapid rise or fall in stock or index prices, known as an open interest spurt, it’s a signal to be careful. This suggests there’s a lot of excitement and potential for high risk in the market.
Any unexpected good or bad news could lead to a significant upward or downward movement in the stock or index.
Example of open interest
The open interest position is calculated daily and can either show a positive or negative change compared to the previous business day. Let’s take an open interest example. Below are the details on NSE open interest for Axis Bank for the January contract.
When you look at the Nifty open interest chart, open interest is 4.44% higher than it was the day before. More open interest means more money coming into the market, while a decrease suggests less interest and possibly a turning point in the price movement.
For traders dealing with financial contracts, they keep an eye on price changes in terms of contract value compared to the actual market prices. These analyses rely on the relationship between futures contracts and their corresponding current prices, also known as cost-of-carry.
This relationship mainly shows how traders feel based on whether the futures contracts are priced higher (premium) or lower (discount) than the current market prices.
Conclusion
Understanding the significance of open interest is a game-changer for F&O trading. It’s not just about numbers; it’s the key to unravelling market trends and sentiment. So, dear readers, don’t miss out on this powerful tool!
Remember, knowledge is your best asset in the stock market. For deeper insights, engage with StockGro – your go-to platform for mastering the art of trading.
FAQ’s?
Open interest is the total number of outstanding futures or options contracts in the market for an underlying asset. Open interest indicates the number of contracts that are yet to be settled in the derivative markets.
Open interest is influenced by two factors:
The number of positions that are opened on a day.
The number of positions that are closed on the same day.
If the number of positions being opened is greater than the number of positions being closed, the open interest increases and vice versa.
Open interest and trading volumes are completely different. This difference can clearly be depicted with a trading example. If one trader sells five lots to another, there is no change in the open interest as there is no net change in the number of positions being opened or closed. However, the trading volume increases by 5.
Rising open interest is an indicator that buying has increased, and hence, it is a sign of a bullish market. However, this is not always the case because if the open interest is extremely high, it can also indicate a reversal. It is important to note that several other factors apart from open interest play a role in determining whether the market trends are bullish or bearish.
A high open interest indicates that there are more buyers in the market. When the number of buyers is higher in the market, it is easier to exit your position. Hence, the liquidity of the contracts increases with an increase in open interest, assuming that other factors remain unchanged.