Open interest is the number of futures or options contracts that have not yet expired, been exercised or fulfilled by delivery. Open interest is often used to confirm trends and trend reversals for futures and options contracts.
What is considered "substantial" open interest is arbitrary, however. For example, The Wall Street Journal will not list a futures contract in their major contract listings unless the open interest is 5,000 contracts or more for all contract months combined. A fund may desire even higher open interest before it includes a contract as part of the fund.
Open interest basically measures the flow of money into and out of the market. For each seller of a contract there must be a buyer of that contract. Thus a seller and a buyer combine to create only one contract.
To determine the total open interest for any given one needs only to know the totals from one side or the other, buyers or sellers, not the sum of both.
The open interest position that is reported each day represents the increase or decrease in the number of contracts for that day, and it is shown as a positive or negative number.
How To Calculate Open Interest
Each trade completed on the exchange has an impact upon the level of open interest for that day.
For example, if both parties to the trade 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.
The third and final possibility is one old trader passing off his position to a new trader (one old buyer sells to one new buyer). In this case the open interest will not change.
Benefits Of Monitoring Open Interest
By monitoring the changes in the open interest figures at the end of each trading day, some conclusions about the day’s activity can be drawn.
Increasing open interest means that new money is flowing into the marketplace. The result will be that the present trend (up, down or sideways) may continue.
Declining open interest means that the market is liquidating and implies that the prevailing price trend may be coming to an end. A knowledge of open interest can prove useful toward the end of major market moves.
A leveling off of open interest following a sustained price advance is often an early warning of the end to an uptrending or bull market.
Open Interest - A Confirming Indicator
An increase in open interest along with an increase in price is said to confirm an upward trend. Similarly, an increase in open interest along with a decrease in price confirms a downward trend. An increase or decrease in prices while open interest remains flat or declining may indicate a possible trend reversal.
The relationship between the prevailing price trend and open interest can be summarized by the following table:
|Market is Strong
|Market is Weakening
|Market is Weak
|Market is Strengthening
- Understanding Volume & Open Interest in Commodity Futures. TFC Commodity Charts/Keystone Marketing Services.
- "Open interest”. www.tradingpicks.com.