SM Trader: Open Interest | Open Interest Vs Volume | Share Market Learning Series

Open Interest

In this post, lets see about Open Interest & how to read OI with Price movement.

Open Interest (OI) is the INTEREST that is OPEN. It is the INTEREST about the POSITIONS of TRADERS. Here OPEN means OUTSTANDING positions.
OPEN INTEREST means POSITIONS of TRADERS which are OUTSTANDING and not yet squared off.
There are only two type of positions that a trader can take in the market. LONG & SHORT.
Now, since for every LONG there is a SHORT and for every SHORT there is a LONG, so we don't count OI as LONG+SHORT but either TOTAL LONGS or TOTAL SHORTS.
They both would always be equal. So, OI is a number that tells you how many futures (or Options) contracts are currently outstanding (open) in the market.
A seller sells 1 contract to a buyer. The buyer is said to be LONG on the contract and the seller is said to be SHORT on the same contract.
The open interest in this case is said to be 1 not 2.

We can tabulate following four condition to understand the link between OI data & price movement.

Price is Rising, and OI is Rising:

If PRICE and OI both are rising, it means that every new contract that is being added is dominated by bulls, that's why PRICE is rising with every new contract addition. Never think that since PRICE is rising, more LONGS are being created than SHORTS.
LONGS will always be equal to SHORTS just that LONGS are dominating SHORTS in the transaction, that is why PRICE is rising.
See, it's like a normal share transaction. Number of shares bought is ALWAYS EQUAL to number of shares sold. Then why PRICE rises or falls?
It does so because of buying pressure or selling pressure. So, if buyers of a share are dominating the sellers,
PRICE will rise and if sellers are dominating the buyers, PRICE will fall. But BUYERS will always be equal to SELLERS.
So, OI is rising, means new contracts are being added. But since PRICE is rising with it, it means that LONGS are DOMINATING the transactions.
Thus, market/share is STRONGLY BULLISH.

Price is Rising, and OI is Falling:

If PRICE is rising but OI is falling, it means that the rise in price is due to SHORT COVERING and not bullishness.
See why is OI falling? It's falling because positions are being squared off and number of open contracts in the market are reducing.
But since PRICE is rising with it, it means that SHORTS are SQUARING OFF and dominating LONGS in the transaction. See, how would SHORTS square off?
They will square off by BUYING. That is why PRICE is rising. So, PRICE is not rising because LONGS are dominating.
It is rising because SHORTS are dominating the squaring off process. Thus, it can not be called BULLISH. It is WEAKLY BULLISH.
It can be a TRAP for new LONGS.

Price is Falling, and OI is Rising:

If price is falling and OI is rising, it means that SHORTS are dominating the LONGS.
And since OI is rising, it means that new contracts are being added.
But, since price is falling, it means the new contracts which are being added are dominated by SHORTS not LONGS. Hence, it is STRONGLY BEARISH.

Price is Falling, and OI is Falling:

If PRICE is falling and OI is falling, it means that the fall in price is due to LONG COVERING or also called LONG UNWINDING.
See why is OI falling? It's falling because positions are being squared off and number of open contracts in the market are reducing.
But since PRICE is falling with it, it means that LONGS are SQUARING OFF & dominating SHORTS in the transaction. See, how would LONGS square off?
They will square off by SELLING. That is why PRICE is falling. So, PRICE is not falling because SHORTS are dominating and creating new positions.
It is falling because LONGS are dominating the squaring off process. Thus, it can not be called BEARISH. It is WEAKLY BEARISH.
It can be a TRAP for new SHORTS.

Volume is number of contracts traded and OI is number of outstanding contracts which are not squared off.
Volume is measured daily & gets reset by end of day, but OI gets accumulated.
Volume gets increased every time a contract is opened or closed irrespective of new or old trader.
If both parties are are initiating a new position (one new buyer and one new seller), open interest will increase by one contract.
If both traders are closing an existing or old position (one old buyer and one old seller) open interest will decline by one contract.
One old trader passing off his position to a new trader (one old buyer sells to one new buyer or vice versa) will not change open interest.

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