What Is Open Interest?

Open interest is the total number of outstanding derivative contracts for an asset—such as options
or futures—that have not been settled. Open interest keeps track of every open position in a
particular contract rather than tracking the total volume traded.

Thus, open interest can provide a more accurate picture of a contract's liquidity and interest,
identifying whether money flows into the contract are increasing or decreasing.

KEY TAKEAWAYS

Open interest is the total number of open derivative contracts, such as options or futures, that have
not been settled.

Open interest is commonly associated with the futures and options markets.

Increasing open interest represents new or additional money coming into the market, while
decreasing open interest indicates money flowing out of the market.

To comprehend open interest, you should understand that traders can buy and sell to open and close
positions.

Understanding Open Interest

Open interest is most often associated with the futures and options markets, where the number of
open contracts changes daily. Open interest is the number of options or futures contracts held by
traders in active positions. These positions have been opened, but have not been closed out, expired,
or exercised.

Open interest decreases when buyers (or holders) and sellers (or writers) of contracts close out more
positions than were opened that day.

To close out a position, a trader must take an offsetting position or exercise their option.

Open interest increases once again when investors and traders open more new long positions or
sellers take on new short positions in an amount greater than the number of contracts that were
closed that day.

Here's a simple scenario—assume that the open interest of the ABC call option is 0. The next day a
trader buys 10 ABC options contracts as a new position. Open interest for this particular call option is
now 10. The day after, five ABC contracts were closed, and 10 were opened. This means that open
interest increased by five to 15.
A common misconception about open interest lies in its ability to make predictions. New traders
might be led to believe that it can forecast price action, but it cannot. High or low open interest only
reflects trader interest and sentiments.

Open Interest vs. Trading Volume

Open interest is sometimes confused with trading volume, but the two terms refer to different
measures. For example, imagine one trader holds 10 option contracts and sells them to a new trader
entering the market. The transfer of these contracts does not create any change in the open interest
because positions were transferred, not closed or opened.

Trading volume, on the other hand, increased by 10 because of the transferral.

The Importance of Open Interest

Open interest is a measure of market activity. Little or no open interest means there are no opening
positions, or that nearly all the positions have been closed. High open interest means there are many
contracts still open, which means market participants will be watching that market closely.

Open interest measures money flow into or out of a futures or options market. Increasing open
interest represents new or additional money coming into the market, while decreasing open interest
indicates money flowing out of the market.

Open interest is significant to options traders as it provides key information regarding the liquidity of
an option.

High open interest creates opportunities to buy and sell. This liquidity helps traders move into and
out of positions quickly. If liquidity is low (low open interest), traders are less able to get in and out of
the market.

Real-World Example of Open Interest

Below is a table of trading activity in the options market for traders A, B, C, D, and E. Open interest is
calculated following the trading activity for each day. The key to understanding how this works is
whether the trader bought or sold to open or close positions.
Jan. 1: Trader A buys one option to open a position from Trader B, increasing open interest by one.

Jan. 2: Trader C buys five options to open a position from D, which increases open interest to six.

Jan. 3: Trader A sells one option to D to close a position, decreasing open interest by one.

Jan. 4: Trader E bought five options from C to open positions, who sold the five purchased from D to
close positions.

Is Higher Open Interest Better?

High open interest usually indicates higher liquidity for a contract. This generally means there will be
less difference between how much a trader wants for an option and how much another will pay. This
can make it easier to buy and sell. If open interest is increasing and becoming higher, this signals that
the market trends around that option are likely to continue.

Is Open Interest Bearish or Bullish?

Rising open interest usually means that there is new buying happening, which is a bullish trend.
However, if open interest grows too high, it can sometimes be a bearish signal that indicates a
coming change in market trends.

What Happens When Open Interest Increases?

When open interest increases, it usually means new money is coming into the market for that
option. As long as this is happening, the current trend will continue. When open interest decreases,
it is usually a sign that the market is liquidating and more investors are leaving. This often means that
the current price trend is ending.

The Bottom Line

Open interest is the total number of open derivative contracts that haven't been settled. They
haven't been exercised, closed out, or expired. This measurement is associated with the options and
futures market rather than the stock market. Open interest is equal to the total number of open
contracts, not the sum of all transactions between buyers and sellers.

When open interest goes up, it represents new money coming into the market. When open interest
decreases, it means money is flowing out of the market. Open interest is not generally viewed as an
indicator of trends or price action.

Using Open Interest to Find Bull/Bear Signals

Traders often use open interest as an indicator to confirm trends and trend reversals for
both the futures and options markets. Open interest represents the total number of open
contracts on a security.
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You can gauge the strength of the market by using volume in conjunction with open
interest.

Here, we'll look at the importance of the relationship between volume and open interest in
confirming trends and their impending changes.
KEY TAKEAWAYS
Many technicians believe that volume precedes price.
According to this theory, increasing volume and open interest indicate continued movement
up or down.
If volume and open interest fall, the theory holds that the momentum behind the movement
is slowing, and the direction of prices will soon reverse.
Contrarian analysts interpret some of these signals quite differently, mainly because they
place much less value on momentum.
Factors Used in Open Interest Bull/Bear Signals
Volume, which is often used in conjunction with open interest, represents the total number
of shares or contracts that have changed hands in a one-day trading session. The greater the
amount of trading during a market session, the higher the trading volume. Volume
represents a measure of intensity or pressure behind a price trend.

Open interest is the number of trades not settled at a given moment for a specific asset. An
increase in open interest suggests that additional or new money is flooding into the market
because more traders have opened positions for the day than closed them. In contrast, a
decrease in open interest indicates that money is flowing out of the market because more
positions close than open.

Price action is the trend prices have taken for the period being evaluated. Price action is
related to volume, and both of these factors are related to open interest because volume
and price follow each other and create interest in opening or closing positions.

So, many traders combine price action, volume, and open interest to create bullish or
bearish market signals.
There are many conflicting technical signals and indicators, so using the right ones for a
given application is essential.
How to Use Bull/Bear Open Interest Signals
The basic rules for price action, volume, and open interest are demonstrated in the following
table:

Price action increasing during an uptrend and rising open interest are interpreted as new
money coming into the market. That reflects new buying, which is considered bullish. If the
price action is rising and the open interest and volume are declining, short sellers covering
their positions are causing the price rally. Therefore, money is leaving the marketplace.
Traders view this as a bearish sign.

If prices are in a downtrend and open interest and volume are rising, some chartists believe
that new money is coming into the market. They think this pattern shows aggressive new
short-selling. This scenario is believed to lead to a continuation of a downtrend and a
bearish condition.

Lastly, if open interest and volume are falling and prices are declining, it is likely caused by
disgruntled long position holders being forced to liquidate their positions. Some technicians
view this scenario as a strong position because they think the downtrend will end once all
the sellers have closed their positions.

According to the theory, high open interest at a market top and a dramatic price fall-off
should be considered bearish. That means all bulls who bought near the top of the market
are now in a loss position. Their panic to sell keeps the price action under pressure.
Criticism of Open Interest Bull/Bear Signals
Other analysts interpret some of these signals quite differently, mainly because they place
less value on momentum. In particular, excessive short interest is seen by many as a bullish
sign. Short selling is generally unprofitable, particularly after a significant downward
movement. However, naive price chasing often leads less informed speculators to short an
asset after a decline. When the market rises, they have to cover. The typical result is a short
squeeze followed by a fierce rally.

In general, momentum investors are not nearly as good at predicting trend reversals as their
contrarian counterparts. While it is true that there is generally more buying and bullish price
action on the way up, the information doesn't benefit investors in deciding when to sell. In
fact, volume often increases before, during, and after major market tops.

Some of the most respected indicators are based on contrarian views. The most relevant
signal here may be the put/call ratio, which has a good record of predicting reversals. The
relative strength indicator is another useful contrarian technical indicator.

How Do You Predict Open Interest?

Open interest is a backward-looking measurement determined by how many positions are
open at a given time. There is no way to predict open interest accurately.

Is Open Interest Bullish or Bearish?

Some traders use open interest with price action and volume to determine whether it is
bullish or bearish. Other traders might only use open interest as an indicator, with views
varying by trader.

How Do You Know If Open Interest Increases or Decreases?

You can view open interest changes on the asset you're interested in on the CME Group's
website. For instance, if you're interested in corn futures open interest, you can navigate to
the settlements page and see the previous days' open interest. You then compare it to open
interest the day before.
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CME Group. "Corn Futures - Settlements."

The Bottom Line

There is no need to study a chart for rule-based signals. If you are a new technician trying to
understand the basics, look at many different theories and indicators. What works for some
assets and investment styles will not work for others. Look at stocks, bonds, gold, and other
commodities and see if a specific indicator works for a particular application.

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