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The Tale of Open Interest

The document discusses open interest (OI) in futures markets. It defines OI as the total number of outstanding futures contracts that have not been closed or delivered on. It provides examples of how OI changes with different types of trades, and explains how to interpret changes in OI together with price movement, in order to gauge market bullishness or bearishness.

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Ram S
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28 views3 pages

The Tale of Open Interest

The document discusses open interest (OI) in futures markets. It defines OI as the total number of outstanding futures contracts that have not been closed or delivered on. It provides examples of how OI changes with different types of trades, and explains how to interpret changes in OI together with price movement, in order to gauge market bullishness or bearishness.

Uploaded by

Ram S
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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THE TALE OF OPEN INTEREST

As the name suggests, Open Interest (OI) is the INTEREST that is OPEN. What is
INTEREST? INTEREST is the POSITIONS of TRADERS. And What is OPEN? OPEN
means OUTSTANDING. So, OPEN INTEREST means POSITIONS of TRADERS
which are OUTSTANDING and not yet squared off. There are only two type of
positions that a trader can take in the market. LONG & SHORT. Now, since for
every LONG there is a SHORT and for every SHORT there is a LONG, so we don't
count OI as LONG + SHORT but either TOTAL LONGS or TOTAL SHORTS. They
both would always be equal. So, as I said OI is a number that tells you how many
futures (or Options) contracts are currently outstanding (open) in the market. So,
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 not 2.
HOW CAN YOU JUDGE BULLISHNESS OR BEARISHNESS WITH OI DATA
1.) If PRICE is rising and OI is rising, it means market is STRONGLY BULLISH.
DESCRIPTION: If PRICE and OI both are rising, it means that every new contract
that is being added is dominated by bulls, that's why PRICE is rising with every
new contract addition. Never think that since PRICE is rising, more LONGS are
being created than SHORTS. LONGS will always be equal to SHORTS just that
LONGS are dominating SHORTS in the transaction, that is why PRICE is rising.
See, it's like a normal share transaction. Number of shares bought is ALWAYS
EQUAL to number of shares sold. Then why PRICE rises or falls? It does so
because of buying pressure or selling pressure. So, if buyers of a share are
dominating the sellers, PRICE will rise and if sellers are dominating the buyers,
PRICE will fall. But BUYERS will always be equal to SELLERS. So, OI is rising,
means new contracts are being added. But since PRICE is rising with it, it means
that LONGS are DOMINATING the transactions. Thus, market/share is STRONGLY
BULLISH.
2.) If PRICE is rising but OI is falling, it means market is WEAKLY BULLISH.
DESCRIPTION: If PRICE is rising but OI is falling, it means that the rise in price is
due to SHORT COVERING and not bullishness. See why is OI falling? It's falling
because positions are being squared off and number of open contracts in the
market are reducing. But since PRICE is rising with it, it means that SHORTS are
SQUARING OFF and dominating LONGS in the transaction. See, how would
SHORTS square off? They will square off by BUYING. That is why PRICE is rising.
So, PRICE is not rising because LONGS are dominating. It is rising because
SHORTS are dominating the squaring off process. Thus, it can not be called
BULLISH. It is WEAKLY BULLISH. It can be a TRAP for new LONGS.
3.) If PRICE is falling, OI is rising, market is STRONGLY BEARISH.
DESCRIPTION: If price is falling and OI is rising, it means that SHORTS are
dominating the LONGS. And since OI is rising, it means that new contracts are
being added. But, since price is falling, it means the new contracts which are
being added are dominated by SHORTS not LONGS. Hence, it is STRONGLY
BEARISH.
4.) If PRICE is falling and OI is falling, market is WEAKLY BEARISH.
DESCRIPTION: If PRICE is falling and OI is falling, it means that the fall in price is
due to LONG COVERING or also called LONG UNWINDING. See why is OI falling?
It's falling because positions are being squared off and number of open contracts
in the market are reducing. But since PRICE is falling with it, it means that
LONGS are SQUARING OFF & dominating SHORTS in the transaction. See, how
would LONGS square off? They will square off by SELLING. That is why PRICE is
falling. So, PRICE is not falling because SHORTS are dominating and creating
new positions. It is falling because LONGS are dominating the squaring off
process. Thus, it can not be called BEARISH. It is WEAKLY BEARISH. It can be a
TRAP for new SHORTS.

DISTINCTION BETWEEN VOLUME & OI


Just remember, volume is number of contracts traded and OI is number of
outstanding contracts which are not squared off. Also remember that volume is
measured daily and OI gets accumulated. Now, we'd understand the concept of
open interest by creating some transactions:
Assume that a new futures contract is out of transactions for January expiry. All
these transaction are happening in a single session.
Initial counters
Volume: 0
Open Interest:0
Transaction 1: Faisal gets LONG 1 future contract which Nishant SHORTED
Open interest: 1
Volume:1
Transaction 2: Abdul gets LONG 1 future contract which SURESH SHORTED
Open Interest: 2
Volume 2
Transaction 3: Manu gets LONG 5 future contracts which Vishal SHORTED
Open Interest: 7
Volume: 7
Transaction 4: Gaurav gets LONG 10 future contracts which Nitin Shorted
Open Interest: 17
Volume: 17
Transaction 5: Naman gets LONG 1 Future contract while Abdul sells.
Open Interest: 17
Volume: 18
Transaction 6: Nishant gets LONG one contract which Naman sells.
OI: 16
Volume: 19
Notes:
1.) Till transaction 4, everything is smooth as new contracts are being created
so open interest and volume, both are rising.
2.) In transaction 5, you can see that volume increased but OI stayed the same.
Volume increased because a trade of a contract happened. But OI stayed the
same because no new contract was opened. Naman got LONG on the same
contract which Abdul carried. Abdul squared his LONGS off by selling and Naman
bought it by going LONG. So the LONG position holder just got replaced in the
contract but no new contract was made so OI remains same.
3.) In transaction 6, you can see that volume increased but OI decreased. You
must have understood the reason as to why Volume got increased. But the
reason that OI decreased is that Nishant who was an existing SHORT, squared
off the contract by getting LONG while on the sell side is Naman who is an
existed LONG and squared off by going SHORT. So, one old LONG and one old
SHORT closed their positions. Thus, one contract got closed and OI reduced by
1.
4.) Bottomline is that each trade completed on the exchange has an impact upon
the level of open interest for that day.
5.) If both parties to the trade are initiating a new position ( one new buyer and
one new seller), open interest will increase by one contract.
6.) If both traders are closing an existing or old position ( one old buyer and one
old seller) open interest will decline by one contract.
7.) The third and final possibility is one old trader passing off his position to a
new trader ( one old buyer sells to one new buyer or vice versa). In this case the
open interest will not change.
I HOPE THE CONCEPT OF OI IS CLEAR ONCE AND FOR ALL
Author: Nishant Arora
https://www.facebook.com/welcometotfs

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