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Module 4   Futures Trading → Chapter 12

Open Interest
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1. 1Background – Forwards Market

2. 2Introducing Futures Contract
3. 3The Futures Trade
4. 4Leverage & Payoff
5. 5Margin & M2M
6. 6Margin Calculator (Part 1)
7. 7Margin Calculator (Part 2)
8. 8All about Shorting
9. 9The Nifty Futures
10. 10The Futures Pricing
11. 11Hedging with Futures
12. 12Open Interest
13. 13Quick Note on Physical Settlement

12.1 – Open Interest and its calculation

Before we conclude this module on “Futures Trading”, we must address one of the
questions that is often asked- “What is Open Interest (OI)?”, “How is it different from
Volumes?”, and “How can we benefit from the Volumes and Open interest data?” Let
me attempt to answer these questions and more in this chapter. After reading this,
you will be able to interpret OI data in conjunction with the Volumes to make better
decisions while trading. Also, I would suggest you refresh your understanding on
Volumes from here.

Open Interest (OI) is a number that tells you how many futures (or Options) contracts
are currently outstanding (open) in the market.  Remember that there are always 2
sides to a trade – a buyer and a seller. Let us say the seller sells 1 contract to the
buyer. The buyer is said to be long on the contract and the seller is said to be short
on the same contract.  The open interest in this case is said to be 1.

Let me illustrate OI with an example. Assume the market consists of 5 traders who
trade NIFTY futures. We will name them Arjun, Neha, Varun, John, and Vikram. Let
us go through their day to day trading activity and observe how open interest varies.
Please note, you need to exercise some patience while understanding the flow of
events below, else you can quite easily get frustrated!

Lets get started.

Monday: Arjun buys 6 futures contracts and Varun buys 4 futures contracts, while
Neha sells all of those 10 contracts. After this transaction, there are 10 contracts in
total with 10 on the long side (6 + 4) and another 10 on the short side; hence the
open interest is 10.  This is summarized in the table below.

Tuesday: Neha wants to get rid of 8 contracts out of the 10 contracts she holds,
which she does. John comes into the market and takes on the 8 shorts contracts
from her. You must realize that this transaction did not create any new
contracts in the market. It was a simple transfer from one person to another. Hence
the OI will still stand at 10.  Tuesday’s transaction is summarized in the table below.
Wednesday: To the existing 8 short contracts, John wants to add 7 more short
positions, while at the same time both Arjun and Varun decide to increase their long
position. Hence John sold 3 contracts to Arjun and 2 contracts to Varun. Note, these
are 5 new contracts created. Neha decides to close out her open positions. By going
long on 2 contracts, she effectively transferred 2 of her short contracts to John and
hence Neha holds no more contracts.  The table now looks like this:

By the end of Wednesday, there are 15 long (9+6) and 15 short positions in the
market, hence OI stands at 15!

Thursday: A big guy named Vikram comes to the market and sells 25 contracts.
John decides to liquidate 10 contracts, and hence buys 10 contracts from Vikram,
effectively transferring his 10 contracts to Vikram. Arjun adds 10 more contracts from
Vikram and finally Varun decides to buy the remaining 5 contracts from Vikram. In
summary, 15 new contracts got added to the system.  OI would now stands at 30.

Friday: Vikram decides to square off 20 of the 25 contracts he had sold previously. 

So he buys 10 contracts each from Arjun and Varun. This means, 20 contracts in
system got squared off, hence OI reduces by 20 contracts. The new OI is 30-20 =
10.  The final summary is listed in the table below.

So on and so forth; I hope the above discussion is giving you a fair sense of what
Open Interest (OI) is all about. The OI information just indicates how many open
positions are there in the market. Here is something you should have noticed by
now. In the ‘contracts held’ column, if you assign a +ve sign to a long position and a
–ve sign to a short position and add up the long and short positions, it always
equates to zero.  In other words, wealth is transferred from buyers and sellers (or
vice versa) and no new wealth is created (like if you hold a stock and stock price
appreciates, then everyone makes money). For this reason, derivatives are often
termed as a zero-sum game!

Have a look at the following snapshot –

As of 4th March 2015, OI on Nifty futures is roughly 2.78 Crores. It means that there
are 2.78 crore Long Nifty positions and 2.78 crore Short Nifty positions. Also, about
55,255 (or 0.2% over 2.78Crs) new contracts have been added today. OI is very
useful in understanding how liquid the market is. Bigger the open interest, more
liquid the market is. And hence it will be easier to enter or exit trades at competitive
bid / ask rates.

12.2 – OI and Volume interpretation

Open interest information tells us how many contracts are open and live in the
market. Volume on the other hand tells us how many trades were executed on the
given day. For every 1 buy and 1 sell, volume adds up to 1. For instance, on a given
day, 400 contracts were bought and 400 were sold, then the volume for the day is
400 and not 800. Clearly volumes and open interest are two different; buy seemingly
similar set of information. The volume counter starts from zero at the start of the day
and increments as and when new trades occur. Hence the volume data always
increases on an intra-day basis. However, OI is not discrete like volumes, OI stacks
up or reduces based on the entry and exit of traders. In fact for the example we have
just discussed, let us summarize the OI and volume information.
Notice how OI and volume change on a daily basis. Today’s volume has no
implication on tomorrow’s volume. However, it is not true for OI. From a stand-alone
perspective both OI and volume numbers are pretty useless. However traders
generally associate these numbers with prices to draw an inference about the
market.

The following tables summarizes the trader’s perspective with respect to changes in
volume and prices –

Price Volume Trader’s Perception

Increase Increase Bullish

Decrease Decrease Bearish trend could probably end, expect reversal

Decrease Increase Bearish

Increase Decrease Bullish trend could probably end, expect reversal

Unlike volumes, the change in Open interest does not really convey any directional
view on markets. However it does give a sense of strength between bullish and
bearish positions. The following tables summarizes the trader’s perspective with
respect to changes in the OI and prices –

Price OI Trader’s Perception

Increase Increase More trades on the long side

Decrease Decrease Longs are covering their position, also called long unwinding

Decrease Increase More trades on the short side

Increase Decrease Shorts are covering their position, also called short covering

Do note, if there is an abnormally high OI backed by a rapid increase or decrease in

prices then be cautious. This situation simply means that there is a lot of euphoria
and leverage being built up in the market. In situations like this, even a small trigger
could lead to a lot of panic in the market.

And with this, I would like to conclude this module on Futures Trading. I hope you
enjoyed reading through this module as much as I enjoyed writing it!

On wards to Option Theory now!

Key takeaways from this chapter

1. Open Interest (OI) is a number that tells you how many contracts are currently
outstanding (open) in the market
 2. OI increases when new contracts are added. OI decreases when contracts
are squared off
3. OI does not change when there is transfer of contracts from one party to
another
4. Unlike volumes, OI is continuous data
5. On a stand along basis OI and Volume information does not convey
information, hence it makes sense to always pair it with the price to
understand the impact of their respective variation
6. Abnormally high OI indicates high leverage, beware of such situations.
 

Updated : 24th Aug 2016 – If you use intra day OI information as a critical input for
your trading strategy, then you should read this before you trade.

1,011 comments
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1.  jagadeesh says:

March 10, 2015 at 1:34 pm

Hi Sir,
Please correct me if I am wrong. I am a price action day trader. I never used OI data till now.
As per me, the trend changes when a valid pivot is broken. Suppose, a trend changing pivot
is triggered with a decrease in OI. Does that mean, people are losing confidence in the trend
and that makes the trend change more trustworthy?? Or, as the OI is decreasing which
means people are not taking any positions in the new trend , hence its better to wait for the
confirmation??

Reply

o  Karthik Rangappa says:

March 11, 2015 at 4:57 am

You can treat it that way…however another way to look at it is when OI increases it simply
means there are too people betting on the same outcome. In fact I personally dont use OI
much.

Reply

o  Shashikiran says:

August 22, 2018 at 11:54 am

Sir
Do we have any chart to monitor OI.

Reply
 o  Faisal Mohammed says:

August 24, 2018 at 12:47 pm

We plan to add OI charts on Kite soon 🙂

Reply

o  Prakash says:

September 25, 2018 at 12:00 pm

Sir by what time we can expect this much needed service of open interest chart along
with price in Kite ??
Eagerly waiting for your response.
Regards!

o  Karthik Rangappa says:

September 26, 2018 at 11:19 am

Its on the agenda, Prakash. We will do this sometime soon.

o  Random says:

June 12, 2019 at 12:31 pm

Now I know, soon means 10 months :p

o  Pravin says:

February 5, 2019 at 7:57 pm

I want you to check the topic”OI and Volume interpretation” from last chapter -‘open
interest’ in the current (futures trading) module .
There are some typing mistakes in the pdf document please correct it , as it is not
convenient for everyone to read it online..please do it fast.

Reply

o  Karthik Rangappa says:

February 6, 2019 at 11:35 am

Can you point them out, Pravin? Thanks.

Reply

o  Andra says:
 May 14, 2019 at 3:18 pm
Hi All,
Forget about Charts, OI will give perfect price action any situation, your chart tells lie, but
not OI data. Learn and trade with only OI. Gives good profits. Just learn only how to read
and trade with OI. Don’t spend any money for learning charts and don’t make trade teachers
to become rich. Need minimum 1 year to understand the OI chain completely to trade on,
later you will become a master. Yes, patience is required to understand OI data, later no
one can beat you.
How may trader teachers work?
If charts works, they will trade and earn. They know they only 50 – 50, that’s why they will
earn by teaching. Yes, you can earn more and more money by teaching than trading. This is
a consistent profit. By trading you may loss, but not by teaching. Many teachers will show
only historical charts and explain all charts. Coming live charts no one ready to predict.
This is my open challenge.

Reply

o  Karthik Rangappa says:

May 15, 2019 at 6:01 am

I have a slightly different opinion on OI. I think on a standalone basis, OI is just a data
point. One needs to associate this with prices to arrive at the right conclusion. End of the
day, these are all based on assumptions and empirical studies 🙂

Reply

2.  Raghavendrachar says:

March 10, 2015 at 4:21 pm

Dear Karthik,
I had bought Nifty 8600 PE 20 lots @ 64, I found that it hit 74 @ 2:36PM when Nifty spot went
to 8680.45 and Fut was 8716.25, I waited for another dip as Ididn’t get chance to square off
there and I kept sell @ 72.2,but @ 2:54PM Nifty spot was @ 8677 and Fut @ 8714 still
8600PE went down only to 69.90!!!,why? finally I had to take loss @ 52.80.

Reply

o  Karthik Rangappa says:

March 11, 2015 at 5:29 am

I guess you are mixing up futures data with options and complicating the whole thing 🙂
8600 is an OTM option, it is relatively less sensitive to prime movements in the spot
(because of lower delta value). Suggest you read this
– http://zerodha.com/z-connect/queries/stock-and-fo-queries/application-of-option-greeks

Reply
 o  Ankit says:

October 6, 2018 at 5:24 pm

You might have hit a low vol scenario. Option prices drop will fall in volatility. This is a thing
that amazes lot of option buyers who are new to the trading world. Check how nifty vix index
moved during that time.

Reply

3.  Vidhyalakshmi says:

March 12, 2015 at 5:16 am

Hi Karthik! Do you know of any good analysis software that offers the option of candles based
on volumes (stocks/contracts) traded…as opposed to the usual time-based candles (weekly,
daily, hourly)? Are there any plans to offer this on Pi?

Reply

4.  Karthik Rangappa says:

March 12, 2015 at 5:54 am

Most s/w including Pi offers something called as ‘Candle volume’ chart which combines
candlestick and volumes. I will try and include a chapter based on this sometime soon.

Reply

o  Vivek aanand says:

December 4, 2018 at 10:12 pm

Sir Plz provide a lecture on volume candle and its effects

Reply

o  Karthik Rangappa says:

December 5, 2018 at 6:38 am

Will try and do that sometime soon, Vivek.

Reply

5.  vasanth says:

March 12, 2015 at 1:01 pm

 Query related to Options:
Today DLF15MAR140CE traded @ 9.25 & DLF15MAR140PE traded @ 3.30 at around
10:30Hours and the spot price is 145. At the EOD Spot moved to 149.2, CE from 9.2 to 11.6
but put down from 3.3 to 2.25rupees. Eventhough the option is far away from the expiry but
why the depreciation in PUT price? Suppose if i used the long straddle strategy chance of
profit in both call & puts. Can you clarify?

Reply

o  Karthik Rangappa says:

March 13, 2015 at 4:24 am

This depends on the sensitivity of the option’s premium to the directional move in the spot.
The 140CE is deep ITM option, whose delta is close to 1, hence the option behaves very
similar to spot. We will talk about this and more shortly in options. All these queries will be
sorted for you. Request you to kindly stay tuned till then. Thanks.

Reply
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