What is open interest in the futures and options segment?
Open interest is the total number of outstanding futures and options (F&O) contracts at any point in time. In other words, these are open or yet to be settled contracts. For instance, if you buy 2 futures contract from trader Y (who is the seller) for apples, then open interest rises by 2.
If another trader A buys 2 futures contracts from trader B, then the open interest for apples rises to 4. Now, if you unwind your position and the counter party is either Y or B (both sellers of apples), then the open interest in the system will reduce by that quantity.
But if you unwind your position, and the counter party is a new entrant, say C, then the open interest will remain unchanged. This is because while you have squared off your position, C’s position is still open. (You might have to read this a few times to make sense of this)
Putting it another way:
Each trade completed on the exchange has an impact upon the level of open interest for that day. For example, 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.
If both traders are closing an existing or old position (one old buyer and one old seller) open interest will decline by one contract.
The third and 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.
What is the use of monitoring the open interest?
While open interest shows the total number of outstanding contracts, the data is not much of use, if looked at on a standalone basis. In the futures segment, open interest data need to be read along with price changes in the futures contract.
* If volume is relatively high while the market is going up and remains relatively low during corrections, the inference is that the market is in a strong uptrend, which should continue.
* If volume is high while the market is going down and relatively light during upward retracements, then the market is weak with a continuing downward trend likely.
* If both open interest and prices are increasing, then new buyers are being brought into the market with a strong technical picture unfolding. Expect the uptrend to continue.
* If on the other hand, open interest is increasing while prices decline, short sellers have the upper hand in a technically weak market. As open interest is growing while prices decline, buyers are obviously the more aggressive party.
* In the event of open interest declining while prices are also slipping, liquidation by long positions is the implication, therefore suggesting a technically strong market overall. In other words, the market is strong as open interest declining suggests no new aggressive shorts, as this would entail an increase in open interest.
* When open interest is declining and prices are increasing, short covering is the most likely cause suggesting that overall the market is weak - i.e. attracting new buyers would be required for a technically strong market and consequently open interest wo |
