The Beginner’s Guide To Option Open Interest

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The definition of open interest as it applies in options trading is very straightforward; it's a number that shows the amount of currently open positions of options contracts. The higher the open interest of a contract, the more open positions there are for it.

Quite simply, it option trading open interest the number of options contracts in existence. Open interest can be measured on a broad scale to show the total number of open options on a particular underlying security, or more precisely it can be measured by the number of a specific type with a specific strike price.

Option trading open interest open interest of an option trading open interest is something that you may want to consider before entering or exiting a particular trading position so you should really understand what it is.

On this page, we explain the following:. When a company becomes listed on a stock exchange they issue a fixed number of shares for sale. Although they can subsequently issue more shares or buy back a number of issued shares and then remove them from the market at any given time, there is a fixed amount of shares in existence.

The same isn't true for options contracts though. There's no minimum or maximum number of contracts that can be written for any particular underlying asset, there will essentially be as many contracts in existence as there needs to be to satisfy the demand in the marketplace.

The actual number of options contracts needs to be tracked so that there is a formal record of how many of them exist at any time, and this is where open interest comes in. When you buy or sell stocks you are trading them with another option trading open interest and the number of stocks in existence doesn't change. They are simply transferred from one party to the other. However, with options contracts, the same ttheory doesn't necessarily apply.

There are two different orders you can place when buying options: There are also two different orders you can option trading open interest when selling them: When you open a new position by placing a buy to open order you aren't necessarily buying contracts that already exist from a option trading open interest that owns them, you could be buying new contracts that are being written by the seller.

Because of this, when you open a new position the number of contracts in option trading open interest could increase which means the open interest of them will go up. If you subsequently close that position by using the sell to close order, they could be sold back to the writer and therefore cease to exist. This would cause the open interest to go down. When you place a sell to open order, you are writing new options contracts to be sold so the open interest would go up.

If you later chose to place a buy to close order on those same contracts, you would be closing your position by buying them back and it would go down. As you can see, the number of options contracts in existence can vary depending on what trades are being made but, in any given day the open interest of an options contract can fluctuate quite dramatically. It's calculated at the end of each day rather than in real time, so whenever you see it quoted it would be accurate up until the end of the previous trading day.

Conversely, a number of traders over value the importance of it, believing it's the sole indicator of the liquidity of the contract. The truth is actually somewhere in the middle.

It's certainly relevant, but it's only one of three indicators of liquidity. The liquidity of options contracts is very important to traders. Liquidity gives you an idea of how easily specific options can be bought and sold at the market price. Highly option trading open interest ones are generally easy to buy and sell, and orders will be filled quickly. Ones with low liquidity, on the other hand, aren't necessarily that easy to trade.

Ideally, you want to be trading ones with a high liquidity to ensure that you can enter and exit positions with relative ease. Options contracts that have a high open interest tend to also have high liquidity, but as mentioned above, there are other factors to consider too. Those other factors are the trading option trading open interest of an option and its bid ask spread. High trading volume of an option generally indicates high liquidity.

Ab small bid does as well. Only by looking at all the relevant criteria is it possible to get a reasonably accurate idea of how to determine how liquid an options contract is. What is Open Interest? On this page, we explain the following: Section Contents Quick Links. Why Open Interest is Recorded When a company becomes listed on a stock exchange they issue a fixed number of shares for sale. Option trading open interest Open Option trading open interest Works When you buy or sell stocks you are trading them with another party and the number of stocks in existence doesn't change.

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It is safe to say that most novice traders in the world are not trading options properly. If we know this, then all we have to do is find the area where most traders are making mistakes and then take the opposite position. We will then have a high probability for success in our trades. Open interest is a statistic unique to options and futures trading. Open interest is the total number of contracts that are currently in existence and have not been offset by closing trades.

This is different than volume which is the number of contracts traded for the day. If you were to buy an option to open a position and the person who sold you the option is also opening a new position, volume would increase by one and open interest would increase by one.

If you then sold your option to someone else who did not have a position, then volume would increase but the open interest would not change as you transferred your interest to someone else. Open interest would have decreased if you had sold your option to someone who had already sold an option and was buying to close their position. Since both of you are closing positions, the option contract is not needed anymore and open interest goes down even though the transaction increases the volume reported.

Understanding open interest can seem confusing at first, but our instructors at Online Trading Academy do an incredible job at making difficult concepts easy to understand in the classroom.

Open interest is important to stock traders and investors as well as option traders. Open interest shows us where traders are putting their money.

Remember that the novice traders are the ones who usually buy options. We can use the knowledge that sellers tend to make money to predict potential price movement for stocks just before the expiration of the stock options. There is a concept in the markets called option pain.

When a seller of an option sees the price of the stock move to where they would lose money, they are feeling pain. By looking at where the open interest of a stock or ETF is, we can make assumptions on the price levels where there would be a lot of pain. Where there is a large amount of open interest, there is also a large probability that the price will not close there by expiration.

This is because if it does, then the sellers of those options would stand to lose a lot of money. In an effort to profit from large option or futures positions, institutional traders will often buy or sell the underlying stock in an effort to push prices to a point where the close will benefit them. This means that the price will often close on options expiration day just above or below the price where the greatest open interest lies and the least amount of pain would be felt.

There is a term for this action, pinning. These traders attempt to pin the price of the stock or ETF to profit from a derivative position. Pinning is illegal in most exchanges in the world and traders who participate in this high volume trading in an effort to manipulate prices could face penalties. The problem is in catching the culprit and the SEC punishing them. But does it really work? That is where the largest open interest happened to be. Since prices opened above this range in the morning, traders should have been looking for opportunities to short the ETF until it settled into the range suggested by the open interest.

So, what can a retail trader do about this pinning? Recognize that it does happen and either stay out of the market or trade the momentum. Trading this can be very risky as you need to be quick in your decision to enter and exit when the momentum is slowing, not reversing.

It is not for everyone, but if you are prepared you may be able to profit from this pinning that occurs in the markets every expiration day. Watching the potential pinning activity in the week before option expiration and also the open interest on the weekly options can also assist those traders looking to make profits on short-term swing trades as well. Trades should only be entered based on supply and demand zones.

The open interest information provided here is only a decision support tool. To learn how to identify the zones accurately and efficiently, visit your local Online Trading Academy office today.

Disclaimer This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk.

The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results.

Reprints allowed for private reading only, for all else, please obtain permission.