Understanding Open Interest in Options

By | February 22, 2014

Many traders have been asking me question on my write up of FII Data analysis, Keeping all the question in mind i have prepared a cheat sheet which will help you in understanding my data analysis with more clarity.

1. What do you mean by Open Interest (OI) in futures and options? 

When there is trade between a buyer and seller, a contract opens and all such open contracts are together called as open interest. So if Trader A have bought 1 lot of Nifty Futures  expecting it to go up and Trader B have sold 1 lot expecting it to go down, that makes it 1 open contract and hence the open interest of 1.

2. How would you read  when I write  “Nifty futures went down with a huge addition of OI?” 

OI will go up when more people start participating or existing people start adding positions. According to the OI theory, typically when a market is going in a particular direction and there is a huge addition in OI, this means there is more conviction in the move.
So if the market is falling and there is a huge addition in OI, this would mean that the existing short positions which are making profits are adding more and hence the fall could be bigger. But understand that this is only theory and may or may not work like this in reality.

3. What would you infer when I write said “ Nifty 6200 CE OI  went up ” 

While trading options, the money required to buy options is much lesser than what is required to write (sell first). So typically the people who write options are people having access to higher capital and hence the logic is that they are more proficient traders.

I guess it is important to also understand why retail traders typically buy options and institutions sell them?

Coming back to the query, when OI for 6200 calls is going up, there are new buyers and sellers (writers) coming in and since the writer is a more proficient trader as explained above, the belief is that he is probably right and better be on his side of the trade which is basically expecting Nifty to not cross 6200.
So if someone says OI on Nifty 6200 calls has gone up significantly, according to the OI logic it means that if Nifty is above 6200 it might come below 6200 and if it is already below 6200, it might find it tough to go above 6200.

4. What would you infer if someone said “OI on Nifty 6000 puts went up significantly?” 

Similar to the explanation given above, since OI is going up on 6000 puts and because the option writer is more proficient generally, the belief would be that the market won’t probably go below 6000 and if it is already below 6000 it might bounce back above 6000.

5.  If I sell 2 lots and there are 2 people X and Y who have bought 1 lot each, assuming we are the only people trading the contract, the OI is 2. What happens if X who has bought 1 lot sells it to another person Z, what is the OI now?

When X sold the lot he had bought from you to Z, a new contract was not created; the existing contract just changed hands so the OI will remain two. But if Z bought say 1 lot from anyone other than X and Y, then that would be a new lot and hence the OI will now go to 3.
Since in the query above a new lot was not created, the OI remains at 2.

 

6. If the market is going down and OI is increasing market could go even lower because of the OI logic. But aren’t both the buyers and sellers increasing, why can’t we look at it like new buyers are coming in so the market might reverse?

Assume the OI is presently 10 on Nifty futures and Nifty is at 5500. This means there are 10 lots long and 10 lots short. The market came down to 5400, so the buyers together have a loss of 50,000 (10 x 5 lots = 500 Nifty x 100 points = 50,000) and the people who are short have a profit of the same.

At 5400, OI went up to 20, basically doubled. When OI went up, either the people who were holding positions from before added or new people came in and bought and sold lots. If you were looking at all of this, which side would you want to be on, long or short?

Understand that at 5400, longs are sitting at 50,000 loss and are weak and shorts are sitting on 50,000 profits and are stronger. The most important logic to make money in the market is to be with the trend, be with the person/stock who is stronger. That is why we infer that if OI went up significantly when market goes in a particular direction, the direction might continue for much longer.

7. Logic behind assuming that if the OI for 6200 calls went up significantly, markets might not cross 6200?

The whole theory of Open Interest conspiracy on options is based on the fact that the buyers of options are mostly retail who are probably not experienced and the sellers/writers are institutions who are more proficient and have been doing it for a while. So if you had to bet, be on the same side as the proficient one because the odds of winning go up.

So when the OI for 6200 calls is going up, there are new buyers and sellers coming in and since sellers are more proficient traders we assume that they are right and hence the market may not go above 6200.

14 thoughts on “Understanding Open Interest in Options

  1. Gjay

    Salute to you , highly appreciated !!! Keep the good work .

  2. Subair

    Dear Sir
    If u dont mind pls explain what will impact if OI increase and decrease in future contract

  3. Chandrashekhar Dhumale

    Hi,

    Kudos once again for wonderful write up and explaining open interest in F&O. Only you can explain the intricasies in such lucid and simple language.
    My Guru, you ought to be a good teacher( sorry, PROFESSOR ), highly knowledgable, yet very simple and humble person and absolutely no.1 Technical Analyst in the country at such an young AGE.

    My warm greeting to you forever.

    Seems like lot to learn from you.

    Thanks once again, waiting to read such articles in future and guidance from you.

    Shekhar.

  4. Bramesh Post author

    This part i cover in my Advanced level trading course..

    Rgds,
    Bramesh

  5. Bramesh Post author

    Keep reading OI data you will understand it better, More you practices more you will get clarity

    Rgds,
    Bramesh

  6. DN Shukla

    Myth of open interest nicely explained in simple words. Saving the writeup in my personnel library.
    Thanks for the explanation.
    DN Shukla

  7. naim shaikh

    Nice info, but its not clear ` buyrs of options are mostly retailers who are probably not experienced (true)and the sellers/ writers are proficient institutions (true again)so if you had to bet, be on the same side as proficient one’ HERE MY QUESTION IS how i know that institutions are writing Calls or Puts?

  8. venkatesh

    Yes excellent one sir, thank you and the last line of the answer to 3rd question is not 5600 but 6200 am I correct sir?.

  9. Siddhartha Ghosh

    Hi Bramesh,

    First of all, heartiest thanks for writing such regular analysis without a miss which is so accurate. It has helped traders like me to stay away from the branded experts who always comes in TV show and change options / directions regularly. Thanks again.

    just one more quick explanations would be of great help, how should we infer whether the net option buying figure by FIIs has taken place on a specific CALL / PUT strike. For ex : you mentioned in one of your previous article that FIIs are buying calls and mostly in 6300 and 6400 call. I understand that there could be a significant change in OI, but is that enough to confirm the specific strike option buying ?

    Would wait for your response.

  10. KAUSHIK

    Dear Sir,

    simply and great explanation… I hope it is enough to clear a doubt about OI… which is importent fector .. specialy when we are trading in short term basis….

    keep it up….

    we are seeking more on this…

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