Open Interest (OI) is an analytical report that offers investors additional insight into the potential supply of a security, in this case a stock. It is complex, and I’ll try to explain it as simply as possible.
In the stock market, most people think of the bid and ask price when they imagine the stock market. However, there is a lot more to the stock market than that.
Understand the open interest: The term Open Interest (OI) is one of the most popular terms among stock traders. In this article we will look at what exactly an open interest is. Here we discuss its definition, what an increase or decrease in open interest means, the difference between open interest and volume, and how open interest should be interpreted. Let’s get started.
Determination of open interest
Open interest is the total number of futures contracts (or options) held by market participants at any given time. The total number of open interest contracts continues to change with each transaction executed. Open interest is considered the best indicator to assess market sentiment and understand the reliability of price movements.
So to have an open interest, there must be a buyer for every seller and vice versa. Here the relationship between buyer and seller creates an open interest. Thus, when buyers and sellers combine and take a new position, the open interest increases by one. And when those same buyers and sellers unwind their positions, open interest falls. But when the buyer and seller transfer their position to the new buyer and seller, the open interest remains unchanged, it is simply a position transfer.
What does an increase/decrease in open interest mean?
An increase in the open interest rate means that new money is entering the market. And it usually indicates that a continuation of the current trend (bull market, bear market or sideways movement) can be expected.
A decline in open interest usually means an end to the current trend is expected and we could see a market reversal. To know the current open interest rate, we only need to know the total amount on the buy or sell side, but not on both sides.
Difference between open interest (OI) and volume
It is a common misconception that RO and volumes mean the same thing. However, these are two different concepts that produce two different data sets. However, both data can be used in combination. Let’s understand the concept of open interest with an example.
Suppose five traders (A, B, C, D, E) trade a Nifty futures contract. Let’s understand how their transaction affects the open interest rate and its calculation.
Monday: A buys 20 Nifty futures contracts and B also buys 10 Nifty futures contracts. While the C 30 Nifty futures were sold in the market. So we have a buying activity of 30 futures contracts and a selling activity of 30 futures contracts. Therefore, the total open interest is 30.
| Dealers | Buying (L = long) | Sales (S = short) | Retained contract |
|---|---|---|---|
| A | 20 | 20L | |
| B | 10 | 10L | |
| C | 30 | 30S | |
| D | |||
| E | |||
| Total | 30 |
Tuesday: C wants to get rid of half of the position, and D enters the market and takes over 15 short contacts from C. Here there was only one position transfer, and no new contracts came in. So the open interest rate would still be 30.
| Dealers | Buying (L = long) | Sales (S = short) | Retained contract |
|---|---|---|---|
| A | |||
| B | |||
| C | 15 | 15L | |
| D | 15 | 15S | |
| E | |||
| Total | 30 |
Wednesday: D would like to add another 15 short contracts. Both A and B want to add 5 long contracts to their existing long positions. And C wants to take 5 more short contracts out of an existing position of 15 short contracts. Therefore, 10 additional long contracts (both A and B) are added to the contract. And the contract between C and D would just be a transfer. In short, Wednesday’s standings will look like this:
| Dealers | Buying (L = long) | Sales (S = short) | Retained contract |
|---|---|---|---|
| A | 5 | 5L | |
| B | 5 | 5L | |
| C | 5 | 5L | |
| D | 15 | 15S | |
| E | |||
| Total | 30 |
Thursday: Trader E decides to enter the market. And wants to sell 50 futures on Nifty. Therefore, trader D decides to terminate his position of 30 slots and transfers his position to trader E. While trader A and B each add 10 slots to their existing positions. A total of 20 new games were added to the system and the final table looks as follows at the end of Thursday:
| Dealers | L | S | Assignments | L | S | Assignments | L | S | Assignments | L | S | Assignments |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| A | 20 | 20L | 20L | 5 | 25L | 10 | 35L | |||||
| B | 10 | 10L | 10L | 5 | 15L | 10 | 25L | |||||
| C | 30 | 30S | 15 | 15S | 5 | 10S | 10S | |||||
| D | 15 | 15S | 15 | 30S | 30 | 0 | ||||||
| E | 50 | 50S |
If we analyze and carefully review the above table, we get a reasonable idea that open interest is ultimately a zero-sum game. If you add up all the long positions and subtract all the short positions from the market. The end result is zero.
Figure 1 : Open interest data (Moneycontrol.com)
Now if we look at the snapshot above (Figure 1), here we see the data showing the action with the largest change in open interest for the day. Open interest has followed the stock price, generally indicating that buying momentum in these ten stocks is likely to continue.
| Short note |
|---|
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– Interpretation of open interest and volume
From the above discussion, it is clear that the IO gives us information about the open contracts and the market. But volume tells us how many transactions took place in the market.
The volume data resets at the end of the day and a new counter starts at the beginning of the next day, but the OI data is a continuation of the previous day. 10 lots purchased and 10 lots traded equals 10 volumes and 10 OIs for the day.
– Open interpretation of interest
| Price | Open interest (OI) | Market expectations |
|---|---|---|
| Enlarge | Enlarge | Most likely to maintain buying momentum |
| Reduce | Reduce | There is a prolonged reversal, i.e. buyers leave the market. |
| Enlarge | Reduce | The market may notice a shortage. |
| Reduce | Enlarge | There could be a reversal in buying momentum as there are more short positions than long positions in the market. |
Supplement
In this article we have tried to simplify the concept of open interest in the stock market and explain what it stands for. Here are some important points to remember from this article:
- The open interest gives you information about the total number of contracts traded on the market.
- This is an excellent indicator to understand market sentiment and expected market dynamics.
- When a contract changes hands, it is only a transfer of position and the open interest does not change.
- Volume data is updated daily, but open interest is continuous data.
So much for this post. I hope this was helpful. If you have any more questions about the open interest in the stock market, please comment below. I’d like to help you. Good business.
Hitesh Singhi is an active derivatives trader with over 10 years of experience in trading futures and options on Indian equities and international energy commodities like Brent, WTI, RBOB, gasoline etc. He has traded on BSE, NSE, ICE and NYMEX. Hitesh’s credits include a degree in business management and an MBA in finance. Follow Hitesh here on Twitter!
Frequently Asked Questions
How do you interpret open interest changes?
A change in open interest is a change in the number of contracts that are trading in the market. This number is calculated by multiplying the number of contracts traded in the last day by the number of days in the month. An increase in open interest is a bullish sign. It indicates that more people are buying than selling and that the market is likely to rise. A decrease in open interest is a bearish sign. It indicates that more people are selling than buying and that the market is likely to fall.
What is the meaning of open interest?
Open interest is the total number of outstanding contracts of a particular security or commodity for delivery on a specific date.
What does open interest tell you?
Open interest is the number of contracts that are currently open for trading. Open interest can be used to determine the liquidity of a security, the depth of the market, and the number of traders in the market.
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