Option trading ideas using open interests

If they were all liquidating at the same time, open interest would drop. Volume remained high, but open interest started to collapse as did the market. They are replaced to some extent by new buyers, who will not be as strong on balance, but the declining open interest is an indication the weak shorts are also bailing. If prices are in a congestion range, and open interest is rising, this is a bearish sign. George Kleinman is President of Commodity. His just released book is Commodity Futures and Options, A Step by Step Guide to Successful Trading. The bulls are in charge.

Another way to look at Rules 1 and 2; as long as the open interest is increasing in a major trend, it will have the necessary financing to draw upon and prosper. You can chart open interest on a price chart, and the direction it is changing can tell you some interesting things. It is easier to find a seller for my buys and a buyer for my sales since there are more participants. The size of the open interest reflects the intensity of the willingness of the participants to hold positions. Open interest goes down by one, when a trader who is long closes out one contract with someone who is already short. It is a quantitative measurement of this difference of opinion.

As long as open interest continues to climb in a bull market, the bulls are in charge. The old bear had to buy to cover, with the other side of this transaction being a sell by the new bear. Rising open interest in a trading range affair assumes the commercials and professionals are taking the short side, and the uniformed public will most likely lose out in the end. Look at the cattle chart. Open interest is the number of contracts outstanding. The reason is the professionals who are more likely to be short, are covering. The open interest number gives you the total number of longs, and the total number of shorts, since in commodity futures, the short interest is always equal to the long interest.

This is important to remember because when you think about the ramifications of changes in open interest you must think about it in the context of which way the market is moving at the time. Open interest numbers go up or down based on how many new traders are entering the market and how many old traders are leaving. If prices are in a downtrend, and open interest is rising, this is a bearish sign. They will be replaced by fresh longs who were not as weakened by the lower prices as the old longs were. If prices are in an uptrend, and open interest is rising, this is a bullish sign. The simple reason has to do with slippage. Weaker longs are being stopped out, but new buyers are taking their place. You can assume that some of the hurt longs have left the party, but they are being replaced by new longs and many existing longs are still there. If a new seller buys back or covers from a new seller entering the market, open interest also does not change.

Open interest is our best indicator of market liquidity. The soybean chart was the drought market of 1988. There are undoubtedly shorts who are being stopped out, but new sellers are taking their place. The reason is the public generally plays the long side. This act creates one new contract. If prices are in a congestion range and open interest is falling, this is a bullish sign. With this in mind, you can plainly see that open interest is a measurement of the willingness of longs and shorts to maintain their opposing positions in the marketplace. They are adding to positions and making the money, thus becoming more powerful. They are adding to their positions, and they are the ones making the money.

The bears are in charge in this case. Note how open interest and volume rose dramatically on the bull move from April until end of June. As the market continues to fall, the shorts get stronger and the longs get weaker. Whenever prices move, someone wins and someone loses; the zero sum game. Open interest statistics are a valuable tool which can be used to predict price trends as well as reversals. The weak hands are throwing in the towel. Once the last weak short was out, and the smart money was long gone, the new folk took it down in a hurry!

Since this contract is now closed out, it disappears from the open interest statistics. Theoretically, one short who had 100 contracts sold could have taken the opposing side of 100 others who each bought one, but the short and long interest are always the same on any particular day. They will be replaced to an extent by new shorts who are stronger than the old shorts were. This is a nicely trending market, trending up, and open interest has been building the whole time. What are the ramifications of an open interest decline? They will be replaced to a degree by new shorts not as strong as they were, but the declining open interest indicates the weakened longs are throwing in the towel to a major degree. Of course, during that day many people closed out, many entered, but the net result was the creation of new open interest. Another way to look at Rules 3 and 4; when the pool of losers is depleted, the party will be over.

The smart money, the shorts, are covering or liquidating. Open interest figures are released daily by the Exchanges, but they are always for the previous day, so they are a day old. Or, if the short holders were on balance taking profits and leaving the party, open interest would also drop. Open interest goes up by one, when one new buyer and one new seller enter the market. Or perhaps 10 new net buyers and sellers of 10 contracts each, or whatever it takes net to create the new 100. As the market continues to rise, the longs get stronger and the shorts get weaker.

If prices are in an uptrend and open interest is falling, this is a bearish sign. The greater the volume the more we can expect the existing trend to continue rather than reverse. As mentioned earlier, a higher volume bar on the chart means that the trading activity was heavier for that day. In itself, it has little value. Volume represents the total amount of trading activity or contracts that have changed hands in a given commodity market for a single trading day. The greater the amount of trading during a market session the higher will be the trading volume. Open Interest is the total number of outstanding contracts that are held by market participants at the end of each day. By monitoring the price trend, volume and open interest the technician is better able to gauge the buying or selling pressure behind market moves. Each trade completed on the floor of a futures exchange has an impact upon the level of open interest for that day.

Another way to look at this, is that the volume represents a measure of intensity or pressure behind a price trend. Technicians believe that volume precedes price, meaning that the loss of money of upside price pressure in an uptrend or downside pressure in a downtrend will show up in the volume figures before presenting itself as a reversal in trend on the bar chart. However, volume and open interest provide important secondary confirmation of the price action on a chart and often provide a lead indication of an impending change of trend. Where volume measures the pressure or intensity behind a price trend, open interest measures the flow of money into the futures market. Technicians utilize a three dimensional approach to market analysis which includes a study of price, volume and open interest. The relationship between the prevailing price trend, volume, and open interest can be summarized by the following table. It is important to understand that the commodity price chart only records the data. Of these three, price is the most important.

This information can be used to confirm a price move or warn that a price move is not to be trusted. In the above example, while open interest increased or decreased depending on the type of trade, trading volume only increased. So, if premiums contract, or discounts widen, along with an increase in OI, it means short positions are being added, and if OI is reducing, then it means long positions are being closed. HOW IS THIS DIFFERENT FROM TRADING VOLUMES? If another trader X buys 20 futures from trader Y, then the open interest accordingly adds to 30. HOW DOES OPEN INTEREST CHANGE? Conversely, an expansion in premium or contraction in discount along with rise in OI means long positions are being added.

Conversely, if price falls along with a rise in OI, then it means more traders are building short positions and pushing the price down. But, if A unwinds his position of 10 futures, then open interest will decrease by 10, because these contracts cease to exist. When A bought 10 futures, trading volume was 10 and when X bought 20 contracts, volume rose to 30. WHAT IS OPEN INTEREST? In derivatives trading, open interest, or OI, is the total number of outstanding futures or options contracts in a market at a given point of time. It is the ratio of total open interest in put options to that of call options. It is measured throughout trading hours and displayed real time on exchange websites and trading terminals. Instead, if A sells these to another trader C, then the open interest remains unchanged since it is C who holds the contracts now. For futures contracts, savvy traders further look at changes in the discount or premium to the spot price to get a clearer picture of the market.

Every futures or option trade has a buyer and a seller. Analysts and traders commonly track open interest to observe unusual buildup of positions in a contract. But if OI has reduced, then it means the inflation is caused by traders covering their short positions. But, when A unwound his position, open interest declined by 10 but trading volume increased to 40. If OI falls along with the price, then it means long positions are being unwound. Each action changes open interest differently. For example, if trader A buys 10 futures contracts from trader B, then open interest is 10. The buyer can hold the contract till expiry or sell it to another buyer or liquidate it before expiry. HOW TO INTERPRET OPEN INTEREST? Scenario: Person A buys to close 5 option contracts to Person C who sells to close 5 option contracts.

This results in a wash, or a passing of the baton if you will. For an option trade to create open interest, the option must be bought to open or sold to open, and not be connected with another trade that is selling to close, or buying to close. Unlike stocks, which have a fixed number of shares set by the company, options are created by traders as they are bought and sold in the market. No new contracts need to be created, because there is still a balance of long and short obligations between the traders. There would be no other traders to potentially trade with and when there are less people to trade with, it becomes more difficult to close out of your positions at fair market prices. The more contracts people are currently long and short the more potential we have for future trading, as the other traders look to buy to close and sell to close their existing positions. The market is larger because there are actually more contracts that can be traded. In the fourth part or our series on liquidity, we are going to discuss open interest. The trade would still increase the option trading volume at that strike price.

This can be a little difficult to understand so we will go over an example. Open interest is a great liquidity indicator because it lets us see how many option contracts are active at a given strike price. Looking at each option transaction as one of these four types of trades will help us understand open interest in more depth. When looking at strike price volume, you could find significant volume paired with low open interest. Open interest measures the current number of active or open option contracts in a given expiration. Scenario: Person A sells to open 5 option contracts to Person B, who buys to open the 5 option contracts. Notes: In the last part of the example when person D sells to open 5 contracts, additional open interest is not created because Person A purchases the contracts to close out of part of their current position.

Open interest does not increase because instead of creating a new option contract, the trade passes an already created contract from one trader to the other. Open interest begins at 0 for all option markets and increases and decreases with demand. How Does Open Interest Help Us Find Liquid Underlyings? Instead of strike price volume being representative of people actively trading, the volume would be from people closing their current positions. There are four ways to look at open interest in dough. You can also view open interest by pulling up the traditional order chain. If the option trader places a trade to close, open interest will decrease.

Thinking about this mathematically, the buyer or seller to open would increase open interest by one, and the buyer or seller to close would decrease open interest by one. When an option trader enters a buy to open or a sell to open trade they create a new position in their portfolio. Single click on call or put, and wait until the data loads on the page. To view open interest data, make sure to log into your brokerage account inside dough first. If there is a lot of open interest, it means there are a lot of outstanding long and short option positions still open. Because options have expirations, they will: expire worthless, be closed, or exercised at expiration. Scenario: Person A sells another 5 option contracts to Person C, who buys to open 5 option contracts. Person D sells to open 5 option contracts to Person A, who buys to close 5 option contracts.