• HDFC securities
• 20 Jan 2023
• Knowledge Centre

Trading in derivatives like futures and options can be a profitable way for individuals to generate returns from the market. It depends upon an individual’s risk appetite. An important term to know in the derivatives market is Open Interest (OI). OI is one of the key metrics used to gauge the liquidity and activity of options contracts. Understanding this concept is crucial for traders who wish to capitalize on trading options.

What is Open Interest?

Open Interest is a number which indicates the total number of options contracts that are currently open in the market. An open contract is a contract which has been bought or sold but the position hasn’t been closed or settled yet.

The OI data represents the number of outstanding contracts in the market. The Open Interest measures the amount of money that is flowing into the market. For each outstanding contract, there is a buyer and a seller. We can understand this concept better with the help of an example.

For example, there are 3 market participants: A, B and C

• On the first day, A and B buy 5 contracts each while C sells 10 contracts. On this day the Open Interest in 10.
• On the second day, A and B want to buy 5 more contracts each. C sells an additional 10 contracts which lead to an increase in Open Interest. The total Open Interest on the second day is 20.
• On the third day, C decides to partially square off the position by buying back 15 contracts. This will lead to a decrease in Open Interest. The OI on the third day will be 20-15 = 5.

How is Open Interest helpful?

Open Interest Analysis can help traders in several ways. Here is how the data is interpreted and used.

Primarily, there are two main options contracts that are traded. A call option and a put option. A trader can analyze the OI data of these contracts to understand the market sentiment.

If the Open Interest of a call option is high, it indicates that there is resistance at that level. For example, if the OI of 18000 CE in Nifty is high, it indicates that 18000 is a strong resistance level. A high OI on a particular level shows that there are many sellers of the particular contract who believe the price would not increase.

Similarly, if the OI of the Nifty 17800 Put Option is high, it indicates that the level of 17800 is a strong support level. There are many sellers of the particular contract and they believe that the market won’t fall below that level.

OI data is one of the many tools that a trader can make use of while trading options. OI can be used with other technical indicators to form a solid trading strategy. Trading options can be risky and one should exercise caution while taking on trades.