What is Open Interest & How Does it Work?

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Options are a mechanism for determining underlying securities of the stock market. If traders want to buy or sell the underlying asset, they can enter into an option contract. However, holders have the option of deciding whether to buy or sell their assets. But before the contract runs out, they have to execute it.

The buying and selling of options by traders influences the cost of option trading in India. To understand the options market, understanding daily trading volume and open interest is essential. These factors can be an important tool for interpreting market developments in options trading. This article explains what open interest in the stock market looks like and how it works.

Understanding Open Interest

Option interest refers to more than just purchasing or selling equities. You either construct new contracts (open them) or liquidate existing ones (close contracts) when trading options. The total number of active option contracts on the stock determines open interest. Active options may be exchanged. However, exercising the right to trade will not cancel them.

Open interest increases and decreases during normal trading so long as the options are more free than closed. A lot of information about options like volume, bid prices, ask prices, and so on is available in the open interest. The two stages of every option transaction are buying and selling. It’s said that the one who buys has a long time in the business, and the one who sells is short. When one contract is sold, and another is bought, the OI is 1.

How Does Open Interest Work?

In the context of their trading strategy, traders often make use of OI with a combination of prices and trade volume daily to forecast price trends and reveal involvement in specific derivative contracts. This element, along with elements such as volume, bid and asking price, is always part of option quotes.

Technical analysts assume that a trend will continue because of the high bullish attitude and the rise in new contract openings when price and OI rise. Technical analysts conclude that a trend begins to decline when the price rises while the OI falls. A reduced OI is a sign that traders are liquidating their positions. Technical analysts deduce that a certain trend is weak when the price falls, and the OI value rises.  Traders believe that the specific trend will strengthen and reverse when the price and the OI value fall.

Importance Of Open Interest

If options have been bought or sold, the Open Interest service does not transmit this information but is a valuable source of information on options trading. To understand “What’s OI in the Options Chain”, it is necessary to take a look at its importance. 

  1. In combination with the volume of trade, it provides a relative understanding of market trends. It indicates a high level of trading in this option over the period if the volume traded exceeds the OI on any given day.
  2. When contracts are added to options trading and when options are closed, open interest increases and decreases. 
  3. The OI will also indicate whether there is a possibility of access to an alternative market. A large number of traders are interested in the company’s options, according to the OI.  The more busy the secondary market is, the better the chance of satisfying options trading at higher prices.
  4. Another observation OI makes is that there is a more favourable liquidity situation for an option contract in the case of high OI. There will be little difference between the price a trader wants to sell and the price a trader wants to buy when there is mutual interest in selling options and buying them. Therefore, the more extensive the OI is, the easier it will be to negotiate a price for options between request and offer prices.
  5. Attention should be paid to the fact that OI doesn’t foresee a bull market or a bear market when considering options. A great company record and growth are not always a sign of high open interest. On the stock exchange, people who traded in large numbers of options may have made bad forecasts. If you notice that the OI is sky-high because it may indicate strong volatility, be careful.

Conclusion

The volume of stock traded on a daily basis provides an insight into the options activity for that day. The trading volume begins at zero at the beginning of the day and continues to grow throughout the day as new transactions take place. By contrast, the OI shall indicate the number of available stock options. These market indicators, of course, change on a daily basis. A share trading app like Share India is best for safe and secure futures and options trading.

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