Open Interest

DEFINITION Open interest (also known as open contracts or open commitments) refers to the total number of derivative contracts, like futures and options, that have not been settled in the immediately previous time period for a specific underlying security. A large open interest indicates more activity and liquidity for the contract. For each buyer of a futures contract there must be a seller. From the time the buyer or seller opens the contract until the counter-party closes it, that contract is considered 'open'.

Knowledge of open interest can prove useful toward the end of major market moves. For some option traders, open interest indicates the intensity of trading in a financial instrument. If open interest increases suddenly, it is likely that new information about the underlying security has been revealed, which may indicate a near-term rise in the underlying security's volatility. However, neither an increase in volatility nor open interest necessarily indicate anything about the direction of future price movements. A leveling off of open interest following a sustained price advance is often an early warning of the end to an uptrending or bull market. A change in open interest indicates a difference in the number of buyers and sellers of a financial instrument. Like volatility, it has no directional component, it is just a tally of unsettled contracts. For example, if trader X buys 2 futures contracts from trader Y(who is the seller), then open interest rises by 2. If another trader A buys 2 futures contracts from trader B, then the open interest rises to 4. Now, if trader X unwinds his position and the counter party is either Y or B, then the open interest in the system will reduce by that quantity. But if X unwinds his position, and the counter party is a new entrant, say C, then the open interest will remain unchanged. This is because while X has squared off his position, Y’s position is still open. The level of outstanding positions in the derivatives segment is one of the parameters widely tracked by the market.

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