Open interest refers to the total number of outstanding derivative contracts, like options or futures, held by traders at the end of each day. It indicates whether the money flowing into the futures and options market is increasing or decreasing. Thus, it is a measure of the total trading activity in the futures and options market.

Calculating Open Interest

Open interest is calculated by adding all the contracts associated with open trades and subtracting all the contracts associated with closing trades. So, if traders A, B, and C are all trading in the same futures market, their trades would affect the open interest as follows:

  • If trader A enters into a long trade by buying 5 contracts, then the open interest increases to 5.
  • If trader B also enters into a long trade by buying 2 contracts, then the open interest increases to 7.
  • If trader C enters into a short trade by selling 3 contracts, then the open interest increases to 10.
In this scenario, when A, B, and C close their trades, the open interest would reduce. However, if A was to enter a trade and B was to close one, while C did neither, the open interest would remain unaffected. Remember, to create an options contract there must be two parties- a buyer and a seller. The contract is considered ‘open’ until the counter-party closes it.

Open Interest vs. Trading Volume

Open interest is often confused with trading volume. However, the two are completely different measures. Open interest refers to the total number of contracts either bought or sold (not both); while trading volume refers to the total number of transactions of both shares and contracts.

Thus, open interest only changes when a new buyer and seller enter the market initiating a new contract, or when a buyer and seller meet and close both positions. The volume would change for any transaction between buyers and sellers of both contracts and shares.

Open Interest as a Market Indicator

Open interest comes into play only in the futures and options market, where the number of contracts changes every day. It is a signal of changes in price movement and reflects investor interest, but cannot, by itself, predict the direction of the price movement.

Therefore, an increasing open interest means that money is flowing into the market, and that the existing market trend is likely to continue. A declining open interest, meanwhile, is indicative of the existing trend coming to an end.

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DISCLAIMER

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.



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