Open Interest is the total number of outstanding contracts that are held by market participants at the end of the day. It can also be defined as the total number of futures contracts or option contracts that have not yet been exercised (squared off), expired or fulfilled by delivery.
Now let us know how the open interest is calculated:
- Trader A sells 1 lot nifty, trader B buys 1 lot Nifty – Total open interest at this price is 2 lots.
- Trader A buys 1 lot nifty, trader C sells 1 lot Nifty – Total open interest at this point is 2 lots.
- Trader D buys 1 lot Nifty, trader E sells 1 lot Nifty – Total open interest at this point is 4 lots.
- Trader D sells 1 lot Nifty – Total open interest at this point will be reduced to 3 lots.
Open Interest can be used to find the upper and lower ranges possible for a script. The strike price of the call option having highest open interest out of all the call option will be the upper range for that script. The strike price of the put option having highest open interest out of all put option will be the lower range for that script.
Let’s make it clear with an example. To determine the upper and lower range of NIFTY, open the option chain and search for the call option which has highest open interest in all nifty call option. Suppose NIFTY 8700 call has highest open interest, then in the short term 8700 will act as upper range.
Similarly to determine lower range, find out the strike price of put option which has highest open interest when compared to all NIFTY put options. This will be the lower range for NIFTY future in the short term. One important point to note is that this strategy works only when days to expiry is between 18 to 10 days.
Other than these there are many benefits of monitoring open interest. Some of them are:
- Increasing open interest means that new money is flowing into the market place. The result will be that the present trend (up, down or sideways) will continue.
- Declining open interest means that the market is liquidating and implies that the prevailing price trend is coming to an end. 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 up trending or bull market.
The relation between open interest and price can be summarized as follows:
|Rising||Falling||Market is weakening|
|Falling||Falling||Market is strengthening|