Open Interest vs Volume: A Tale of Two Market Indicators
Volume is the total number of options contracts bought and sold in a particular time period (for instance, a single day). It’s calculated for every contract (by strike price, call, or put). Open interest is the number of open positions (outstanding contracts) for an option. These would be positions not yet expired, exercised, or closed out by an offsetting trade. Each can provide insight into trader demand, market liquidity, and potential price moves.
- Open interest measures the total number of open contracts for any specific option.
- Open interest tallies the total number of outstanding derivative contracts, such as futures or options, that have not been settled.
- Volume refers to the number of contracts traded in a day, while open interest represents the total number of open contracts.
- For example, if five investors collectively buy 2,000 of a specific put option contract that has the same strike price and expiration date, then the trading volume for that contract that day is 2,000.
- Open interest is the number of open positions (outstanding contracts) for an option.
A ratio above 1 can indicate bearish sentiment, while a ratio below 1 may suggest bullish sentiment. However, it can also be used contrarily, where a high put-call ratio might signal a market bottom and a low ratio might signal a market top. If open interest increases, it means that more contracts are being opened than closed. This could be a sign of new money entering the market, potentially indicating a strong trend. Volume can exceed open interest during a trading day as contracts are traded back and forth. However, by the end of the day, open interest will adjust to account for the net change in contracts.
Open interest data is typically provided alongside other trading data like price and volume. Many trading platforms and financial news sites include open interest in their data. On the flip side, volume is the total number of contracts traded in a day. It’s like the number of guests that walked in and out of your party in total. Some may have stayed, some left, but they all contributed to the day’s volume.
As volume increases, the bid-ask spread typically decreases, which leads to more efficient pricing. The greater the volume, the more the activity in a contract, which is why investors usually view volume as an indicator of the strength of a particular price movement. Thus, when the volume is high, there is greater liquidity in the contract, which is desirable for short-term traders, as it means that there is an abundance of buyers and sellers in the market. Comparing open interest with volume (the total number of options and futures contracts that have traded on a given day) can provide insights into the strength or weakness of a price move. For example, increasing prices, along with increasing volume and open interest, can signal the start of a new uptrend.
The volume counter starts from zero at the start of the day and increments as and when new trades occur. However, OI is not discrete like volumes, OI stacks up or reduces based on the entry and exit of traders. In fact for the example we have just discussed, let us summarize the OI and volume information.
Trending Analysis
When open interest decreases, it means money is flowing out of the market. Open interest is not generally viewed as an indicator of trends or price action. When open interest increases, it usually means new money is coming into the market for that option. When open interest decreases, it is usually a sign that the market is liquidating and more investors are leaving. Open interest decreases when buyers and sellers close their existing positions. The closing orders offset and reduce the contract’s open interest because that contract no longer exists.
Investors see volume as an indicator of the strength of a trade. The higher the volume, the more interest there is in the security. Higher volume and, therefore, greater liquidity also means it will be easier for a trader to get out of a security faster if need be. In summary, open interest increases when two parties get filled on opening orders, and decreases when two parties get filled on closing orders. When one party has an opening order and the other has a closing order, opening interest will not change (assuming both orders have the same number of contracts). Here, Trader A is buying-to-open 5 contracts to open and Trader B is selling 5 contracts to open.
While trading volume helps indicate activity in a security, it only shows the number of contracts and not the number of buyers or sellers. As a result, a single large purchase from an institutional investor might suggest broader activity than is actually occurring on that option. Investors should therefore use trading volume in conjunction open interest vs volume with other indicators to interpret past or current price action. Below is a table of trading activity in the options market for traders A, B, C, D, and E. Open interest is calculated following the trading activity for each day. The key to understanding how this works is whether the trader bought or sold to open or close positions.
How does open interest and volume impact a trade?
A “good” open interest can vary depending on the specific situation and the size of the underlying market. In general, higher open interest means more liquidity, which can provide more opportunities for traders. Open interest also has a special relationship https://1investing.in/ with price movements. Let’s say the price of Techtron contracts is rising, and so is open interest. This could mean that new money is flowing into the market, suggesting a strong uptrend. Open interest can give you a sense of the liquidity of a contract.
Open Interest and Volume Singing Different Tunes
Additionally, it’s harder to get out of option positions at good prices when volume and open interest are low, which means losses may grow larger due to the inability to exit a position. An option’s volume and open interest are very important to you as an options trader because you do not want to get caught trading illiquid options (low volume and low open interest). Illiquid options tend to have wide bid-ask spreads, which can single-handedly wipe out a trading account over time. So, open interest represents the number of option contracts that are open in the market between two parties, though you don’t need to be concerned about the specific parties. If both traders are filled on their orders, the option’s open interest will increase by 5 because two traders have opened positions in that contract.
However, if open interest grows too high, it can sometimes be a bearish signal that indicates a coming change in market trends. Open interest measures money flow into or out of a futures or options market. Increasing open interest represents new or additional money coming into the market, while decreasing open interest indicates money flowing out of the market. A common misconception about open interest lies in its ability to make predictions. New traders might be led to believe that it can forecast price action, but it cannot.
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Whereas, volume measures the trade for a specific period and specific security. Inversely, open interest decreases when positions in the existing contracts are closed out by buyers (aka holders) and sellers (aka writers). A lower open interest indicates a disinterest by investors in opening new positions. Particularly at the key support and resistance levels, a change in Open Interest and volume can be probable predictors and warn traders in advance that market sentiment is undergoing a change.