THE OPEN INTEREST

OPEN INTEREST is an important factor  that investors should observe when trading in options.

What exactly is open interest?

It refers to the number of contracts outstanding on a particular day. Suppose the open interest in ABC October 100 calls is 645 contracts.

This means that 645 contracts are due for delivery on expiration of the option on the last Thursday of the month.

Open interest is different from volumes. Suppose you buy one contract of ABC 100 call from me, the open interest is one contract, as is the volume in that option.

Now, suppose you immediately sell the 100 call to another person, the volumes will increase to two contracts. The open interest, however, remains at one!

The reason is, as you have sold an option that you bought earlier, you are out of the market, while another person has entered for the first time.

So, this new trader is long in one contract, while I am still short one contract. Therefore, the open interest is only one contract..Open interest can be used to read the sentiment in the stock concerned.

Observe the open-interest-to-volumes ratio. If this ratio is low but rising, it means that the volumes traded are higher than the open interest. This is an indication that traders are accumulating the option.

In such cases, the rise (change) in open interest over the previous day will be far higher than the rise (change) in volumes.

For instance, open interest may rise from 25 contracts to 100 contracts (300 per cent increase) while volumes may rise from 200 to 400 contracts (100 per cent increase).

Such a signal in a call option may well mean that the stock could move up.

If such a signal occurs in a put option, it may well mean that the stock could move down.

I hope this may prove useful for traders/investors to know what they are buying /selling and why. This is applicable for the stocks that are traded in derivatives such as Futures and Options. In the same line, friends can also track Future contracts.

Friends may keep track of  Open Interest and Volume in NSE website.

Thanks

DEEPA ACHARYA

Compiled by D.A. 

N.B. Trading in options though highly rewarding, time erosion brings loss to many traders. Therefore  it is suggested to quit options if the value goes down by 25% and save entire capital erosion. TRADING IN LIQUID OPTION IS HIGHLY RECOMMENDED