Open Interest vs. Volume
Relationship Between Open Interest And Price, Analyzing market situations is one of the most challenging jobs, and it is when indices, metrics, and data come into the picture and make the job easier. Research and the right tools are the most important factors when analyzing the market situations and making a decision. The smallest indicator can make a bigger difference when analyzed in the right way. Two of the most common indicators are open interest and volume useful in understanding the trading and market situation.
Definition – Volume
Volume in context with trading is defined as a trade measure within a specific period for a specific type of security. Trading volume is one of the best indicators for a particular security market activity and directly shows its liquidity value in the market. Entire numbers are calculated and tracked by the market exchange, and at the end of the market day, the total metric is calculated. When these numbers are higher, it reflects that other investors have an active interest in a particular security, and then accordingly, the orders can be executed. Also, suppose the trading volume is higher with a price change. In that case, there is a favorable opportunity to invest as the volume metric validates the direction, which helps investors make a choice.
Definition – Open Interest
Open interest in the context of trading is defined as the number of contracts in options and futures contracts that are active or not settled for an asset at a given point in time. This indication is used to mark the positions of the securities in the market that, for whatsoever reason, has not yet closed. The open interest increases and decreases as per the market fluctuations; it increases when new contracts are created and decreases when positions in the existing contracts are closed by the buyer and seller. The higher number of open interests signifies more buyers and sellers for a particular security. Overall, the open interest is used as an indicator of liquidity and market activity. On the other hand, the lower values of open interest indicate that investors are not interested in opening new positions and closing existing positions.
Open Interest and its calculation
Before we conclude this module on “Futures Trading”, we must address one of the questions that is often asked- “What is Open Interest (OI)?”, “How is it different from Volumes?”, and “How can we benefit from the Volumes and Open interest data?” Let me attempt to answer these questions and more in this chapter. After reading this, you will be able to interpret OI data in conjunction with the Volumes to make better decisions while trading. Also, I would suggest you refresh your understanding on Volumes from here.
Open Interest (OI) is a number that tells you how many futures (or Options) contracts are currently outstanding (open) in the market. Remember that there are always 2 sides to a trade – a buyer and a seller. Let us say the seller sells 1 contract to the buyer. The buyer is said to be long on the contract and the seller is said to be short on the same contract. The open interest in this case is said to be 1.
Monday: Arjun buys 6 futures contracts and Varun buys 4 futures contracts, while Neha sells all of those 10 contracts. After this transaction, there are 10 contracts in total with 10 on the long side (6 + 4) and another 10 on the short side; hence the open interest is 10. This is summarized in the table below.
- Open Interest (OI) is a number that tells you how many contracts are currently outstanding (open) in the market
- OI increases when new contracts are added. OI decreases when contracts are squared off
- OI does not change when there is transfer of contracts from one party to another
- Unlike volumes, OI is continuous data
- On a stand along basis OI and Volume information does not convey information, hence it makes sense to always pair it with the price to understand the impact of their respective variation
- Abnormally high OI indicates high leverage, beware of such situations.