Open interest is a powerful data point in Futures and Options. Let’s explore what it is and why traders love it.
First of all it tells us how many contracts are open and live i.e. outstanding in the market, due to delivery/settlement or trader discretion for this call.
Increasing open interest represents additional money coming into the market while decreasing open interest shows money flowing away.
The contract is considered “Open” until the counterparty closes it.
If a buyer and seller initiate a new position on the contract, OI rises by 1. If they both exit a contract position on a trade, then OI falls by one. If a buyer or seller passes off their current position to a new buyer or seller, then OI remains unchanged.
Calculating Support and Resistance
Time plays a key factor in options trading. Due to this reason, generally, there is more sellers’ presence in the market than buyers.
A Call options seller stands on the bearish side, and a Put options seller holds a bullish view of the market.
So, if a huge Open Interest build-up is visible, then it signifies something important.
This additional OI for any certain strike price defines the possibility to calculate support and resistance level.
For the call option, a huge OI depicts a possible resistance level, and the put option signifies a possible support level at that strike price.
High Open Interest in (Call and Put)
These indicate the level at which traders have built positions expecting the market to either go up or down.
A high OI build-up for a call option at a particular strike implies resistance at that strike price. A high OI build-up for a put option at a particular strike implies support at that price.
Why is Open Interest Important?
By analyzing OI carefully, traders can understand where the smart money is betting.
You can gauge the short-term support and resistance for the market.
The highest PUT option OI strike will be the support, and the highest CALL OI strike will be the resistance for the market.
Note: OI is always seen from the seller’s perspective because the selling of the option needs more (margin money) and has unlimited risks.
It is assumed that sellers have better access to information, so they are risking their capital.
It is assumed that the highest put OI strike has maximum put sellers and the highest call OI strike has maximum call sellers.
Understanding Support & Resistance
For example, the 36,500 strike put has the highest OI among all the puts and the 37,000 strike call has the highest OI among all the calls.
This means 36,500 put has the highest number of sellers so the market breaching this level is unlikely, so this is the support for that particular expiry for Bank Nifty.
Whereas 37,000 has the highest call OI, so it will work as a resistance.
OI is applicable for future Option contracts and can identify potential support and resistance level by observing the Open interest from the options chain.
One buy and one sell transaction in the same contract with the same expiry creates one open interest.
Outstanding open interest is the total number of options outstanding.
Open Interest helps us understand the support and resistance for the underlying.
The change in open interest helps identify the change in market sentiment and the next possible support and resistance level to track daily changes.