Open interest is the volume of open positions in a futures or financial options contract at a specific time. This concept is also known as Open Interest .
To simplify the explanation, the concept will deal only with the futures market. However, everything explained will be applicable to the options market. Open interest is also defined as the number of contracts that investors who have taken long positions are required to buy . And, since it is a zero-sum game, the amount of contracts that investors who have taken short positions are required to sell at maturity .
Example of calculation of open interest
To simplify the explanation of the concept we will assume that there are two people operating in a futures market. A single operation is performed. One person opens a long position and the other takes a short position, the opposite. Remember that in the futures markets for each buyer there must be a seller. And vice versa, for each seller there must be a buyer.
So that in the clearing house of this futures market there is only one transaction. Distinguishing that yes, two parts. A buying part and another selling part.
The open interest will then be of a contract. And the negotiated volume will also be from a contract. There are two people, two opposite positions, but only one contract.
After three days, people decide that they want to close their corresponding operations. The buyer wants to close his long position and the seller wants to close his short position.
At the end of the day, the clearing house records an operation. Cancel the positions of the two people. At the close the negotiated volume is of a contract. However, the open interest is zero. Why? Because there is no position in the market.
Interpretation of open interest
According to the investment manuals, the order of importance is such that: price, negotiated volume, open interest. In this sense, open interest is used to confirm the movement of an asset. In the financial markets there are no fixed rules. Below are some examples of interpretation of open interest.
- Bullish trend The negotiated volume and open interest increase. The upward trend is strong and most likely to continue.
- Bullish trend The negotiated volume increases and the open interest is reduced. The upward trend is likely to slow down or even the price to turn down.
- The negotiated volume and open interest increase. The downtrend is strong. Selling pressure is increasing and most likely the price will continue to decline.
- The negotiated volume increases and the open interest is reduced. The downward trend is likely to slow down and the price may even turn up.
- Lateral tendency. The negotiated volume and open interest increase. In case of perforation of a supportor resistance increases the probability that the perforation is not false.
- Lateral tendency. The negotiated volume and open interest are reduced. In case of perforation of a supportor resistance, it is most likely that the perforation is false.
Apart from these examples, each market has its peculiarities. For example, the commodity futures market is subject to seasonal changes. Analyzing open interest should always be done alongside the negotiated volume. The analysis will also depend on the experience of the analyst. And from factors external to volume and open interest. So we must keep in mind that there are many different interpretations. Finally, we must remember that we always talk about what is likely. Since knowing how the price will move is impossible.