Open interest are also referred to as open contracts or open commitments. The total number of derivative contracts are denoted by them, like futures and options, that are currently active on a specific underlying security. The flow of money into the futures market is measured by open interest. There must be a buyer of that contract for each seller of a futures contract. Thus a seller and a buyer are joined to create only one contract. Therefore, we need only to know the totals from one side or the other, buyers or sellers, not the sum of both in order to determine the total open interest for any given market.
The increase or decrease in the number of contracts for that day is represented by the change in open interest that is reported each day, and it is shown as a positive or negative number.
Example of Open Interest
For the IBM call option that hit 90 and expiring in January 2007, on February 10, 2006 the total open interest on was 10251.
Interpretation of Open Interest
For the traders of option, open interest is an indication of the intensity of trading in the options of an underlying security. For example, if there is a sudden increase in the open interest from one day to the next, it is the possibility that new information about the underlying security has been revealed, by which a near-term rise in the underlying security’s volatility may be indicated. Theoretically there’s nothing which can be said on the future direction of the underlying, due to the reason that there are as many contracts bought as sold.
If the changes in the open interest figures are monitored at the end of each trading day, then there is the possibility that some conclusions about the day’s activity can be drawn. It is implied by the increasing open interest that new money is flowing into the marketplace. As a result of this will be that the present trend (up, down or sideways) will continue. Whereas it is implied by the declining open interest that the market is liquidating, and suggests that the prevailing price trend is coming to an end. If traders have a knowledge of open interest then it can prove useful toward the end of major market moves.
It is usually an early warning of the end to an up trending or bull market if an open interest is leveling off following a sustained price advance.
On the basis of studies that have been carried out in international exchanges, it was found that open interest is largest in the near month expiry contracts.
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