Updated: Apr 8, 2021
Welcome to yet another article regarding the options trading strategies. This is the article dedicated to advanced option trading strategies. In this article, we are going to learn about the call and put open interest.
In options trading, call open interest and put open interest give you a lot of information that can help you to decide where the markets go including what can be the direction of the market. In this article, I am going to talk about the call and put open interest and how you can predict the direction of the market.
This is the advanced options trading article. We are aware that various indicators can help us to judge the market direction. We already discussed indicator number 1 which is the future interest and now we are going to talk about the call and put interest. Just to summaries, we are discussing options trading strategies. The first itself was the market view and to make a market view, we have to discuss various types of indicators that will keep us updated about the market movement.
Open interest is the number of options or futures contracts that are carried by traders and investors in active positions. These options positions have been opened, but have not been closed yet and expired also. Open interest decreases when buyers and the sellers (or called option writers) of contracts close more positions than were opened on that day.
To close out a position, a trader must exercise their options contracts. Open interest increases once again when investors and traders open more the investor take long and short positions in an amount greater than the number of contracts that were closed that day.
For example, assume that the open interest of the XYZ call option is 0. The next day an investor buys 100 options contracts as a new position. Open interest for this specific call option is now 100. The day after, five contracts were closed, 10 were opened, and open interest increases by 95 to 105.
Increasing prices during an uptrend while open interest is also on the rise can signify that new money is coming into the market. This could be a sign of a bullish market if the increase in open interest is being introduced by the buyers.
If, however, open interest is on the reducing sign while prices are rising during an uptrend, that could be seen that money is leaving the marketplace, which would be a bearish market sign.
Falling prices in a downtrend while open interest is on the rise might advise that new money is coming into the market on the selling side. This storyline is consistent with a continuing downtrend and is bearish.
But, falling prices in a downtrend while open interest is on the reducing side could specify that holders are being imposed to liquidate their positions, which would be a bearish market sign. This storyline also could mean that selling can be done shortly market.
If there is a high level of open interest while prices are going down sharply during a market top, it could be a bearish market sign if holders who bought near the top are now decreasing their money; this also could cause an environment of panic selling.
So, open Interest is a very unique parameter while trading in the futures and options market. Open Interest is the total number of contracts that are currently in existence and are not offset by the closing of trades. Open Interest is not the same just like the volume. What is Volume? Volume is the number of options contracts traded per day.
If you are buying a future/options contract, then you are opening a new position and the person who sold you is also opening a new position. The volume shoots up by one and open interest would also increase by one. If you exchange your future or options contract to someone else who did not have a position in the market, then the volume will increase but the open interest master plan will not change as you have moved it to someone else that did not have any position in the market earlier.
Open Interest is very essential for both stock futures traders as well as options traders. Open Interest tells us where the traders are putting their money in. Therefore, analyzing and creating a new open interest strategy is very crucial. You should analyze the open interest data with the help of stock in the futures market.
As we know, due to the intrinsic time decay of the premium of options, there are generally large numbers of option sellers in the market. For option sellers, the profit is maximum the premium price of the option sold, while loss probability is unlimited. Hence these option sellers are generally very fast to square off their positions in case of any adverse movement.
So, in conclusion, I would like to tell you that there is no need to study a chart for rule-based observation. If you are new in the options trading strategy trying to understand the basics, look at many different theories and indicators. What works for some indicators and investment styles will not work for others. Look at stocks price, their call-put ratio, their open interest, their implied volatility, and see if a specific indicator works for a specific application.