## 12.1 - Open interest and its calculation

First, we must answer the question: "What is Open Interest (OI)?, before we can conclude the module on "Futures Trading". This chapter will help you to understand OI data and make better trading decisions. You might also want to refresh your knowledge on Volumes from .

Open Interest (OI) is a number that indicates the number of Options (or futures contracts) currently open (outstanding). There are always two sides to any trade: a buyer or a seller. Let's say that the seller sells one contract to the buyer. The buyer is long on the contract, while the seller is short on the identical contract. In this instance, the open interest is 1.

Let me give you an example of OI. Let's say that the market is made up of five traders who trade NIFTY options. They will be called Arjun, Varun Varun, John and Vikram. Let's look at their trading activity every day and see how the open interest changes. You must be patient and understand the flow of events below. Otherwise, you could easily become frustrated.

Lets get started.

Monday: Arjun purchases 6 futures contract futures, Varun buys 4, and Neha sells every one of the 10 futures contracts. There are now 10 total contracts, 10 on each side (6 + 4), and 10 on each side (10 + 4); hence the open interest of 10. The table below summarizes this information.

Tuesday: Neha would like to get rid 8 out of 10 contracts that she has. She does. John enters the market and accepts the 8 shorts contracts she holds. This transaction did not create any new contracts in the market. It was a simple transfer between two people. The OI will remain at 10. The table below summarizes Tuesday's transaction.

Wednesday: John will add 7 short positions to the 8 existing short contracts. Varun and Arjun also want to increase their long positions. John therefore sold 3 contracts to Arjun, and 2 to Varun. These are 5 new contracts. Neha closes her positions. She took 2 contracts long and effectively transferred John 2 of her short contracts. Neha now has no contracts. This is how the table looks now:

At Wednesday's end, the market had 15 short (9+6) positions and 15 long (9+6) positions. Therefore, OI stands at 15.

Thursday: Vikram, a big man, comes to the market and purchases 25 contracts. John decides to sell 10 contracts and buys 10 from Vikram. This effectively transfers his 10 contracts to Vikram. Varun buys the remaining 5 Vikram contracts, and Arjun then adds 10 contracts from Vikram. 15 additional contracts were added to the system. OI now stands at 30.

Friday: Vikram agrees to sell 20 of the 25 contracts that he has previously sold. He buys 10 contracts from Varun and Arjun. This means that 20 contracts were resold, and the OI decreased by 20 contracts. The new OI is now 10. The table below contains the final summary.

You can go on. I hope you get a good idea of Open Interest (OI). Open Interest (OI) information simply indicates the number of open positions in the market. This is what you should know. If you add up the positions in the 'contracts held column and assign a +ve to a long position and subtract a -ve from a short position, the result is always zero. This is why derivatives are often called a zero-sum game.

Take a look at this snapshot.

The OI for Nifty futures was approximately 2.78 Crores as of the 4 th March 2015. This means that there are 2.78 million Long Nifty positions, and 2.78 million Short Nifty positions. Today, there have been 55,255 new contracts, which is 0.2% more than 2.78Crs. OI is an important tool in understanding the liquidity of the market. The market will be more liquid if there is more open interest. It will therefore be easier to trade at competitive ask / bid rates.

## 12.2 - Volume and OI interpretation

Open interest information shows us the number of contracts that are currently open and active in the market. Volume, on the other side, tells us how many trades have been executed in a given day. Volume is the sum of 1 buy and 1 sale. If 400 contracts are bought and 400 sold on a given day then the volume is 400, not 800. Volumes and open interest are clearly two different things. However, you can find similar information. The volume counter begins at zero at the beginning of each day, and increases as new trades are made. Volume data is always updated on an intra-day basis. OI, however, is not discrete as volumes. OI changes based on traders' entry and exit. Let's take a look at the OI and volume information in the case we just mentioned.

You can see how OI and volume fluctuate on a daily basis. Volume today has no bearing on volume tomorrow. OI is different. OI and volume numbers can be considered in isolation. These numbers are often used by traders to infer market conditions.

These tables summarise the perspective of trader with regard to price and volume changes.

IncreaseAugmentationBullish
DiminutionDiminutionExpect a reversal of the bearish trend.
DiminutionIncreaseBearish
IncreaseDiminutionExpect a reversal of bullish trend.

The change in Open interest, unlike volumes, does not convey any direction to markets. It does however give an indication of the strength between bearish and bullish positions. Below are the following tables that summarize the perspective of traders on changes in OI and prices.

SteigerungIncreaseTrades on the long side are more common
DiminutionDiminutionAlso known as long unwinding, longs cover their position.
DiminutionIncreaseTrades on the short side are more common
SteigerungDiminutionShorts, also known as short covering, are used to cover their position.

Be cautious if you see an unusually high OI coupled with a rapid rise or fall in prices. This is simply a sign that the market is experiencing a lot more euphoria or leverage. Even a tiny trigger can cause panic in markets like these.

This concludes the module on Futures Trading. I hope you enjoy reading this module as much I enjoyed writing it.

Now, wards for Option Theory!

## To Summarize

1. Open Interest (OI), a number that indicates how many open contracts there are, is an indicator of market activity.
2. OI rises when new contracts are created. OI drops when contracts are canceled.
3. OI does NOT change when contracts are transferred from one party to the other
4. Unlike volumes, OI is continuous data
5. OI and Volume information do not provide information on a standalone basis. It is therefore important to pair it with the price in order to fully understand the impact of each variation.
6. Beware of situations where OI is abnormally high. This could indicate high leverage.