Introduction to Open Interest
Open interest is the total number of outstanding contracts that are not settled for an asset and held by the market participants at the end of the day. Open interest measures the total level of activity in the futures market and provides a clearer picture of the options trading activities and if the money flow in the market is increasing or decreasing.
Understanding the Open Interest
For every option contract that exists, there is one buyer and one seller as the buyer cannot sell the contract without the seller. The buyer and seller together create one contract which is equal to a 100 shares of the underlying security or asset. This contract remains open until either party decides to close it.
If these two parties, that is the buyer and the seller, are initiating a new position that can be either a new buyer or a new seller, then the open interest increases by one contract. If these two parties decide to close an existing position then the open interest declines by one contract. However, if one position is initiated while another is declined, the open interest remains the same.
When the open interest increases it means the money flow in the market is increasing while when the open interest decreases it means the money is flowing out of the market.
It’s important to note that the open interest is the total number of contracts from one side, either buyer or seller. That means to determine the open interest you need to know the total number of contracts bought or sold and not the sum of both.
The open interest number only changes when a new buyer or seller enters the market and creates a new contract. This can also happen when both the parties that are the buyer and the seller decide to create a position or decline a position.
What is the Importance of Open Interest?
Open interest measures both the market activity and the flow of money in the market. When the open interest is high it means many contracts are open in the market which means there are chances for many participants. Whereas, when the open interest is low, it means there are merely any open contracts and most of the positions are closed.
Open interest indicates the liquidity of the market and is very important for options traders, as it helps them to understand the liquidity of options in the market.
