Open Interest vs Volume

Open interest and volume are two often misunderstood terms in options trading. Many times, the traders confuse the two of them making their options trading journey chaotic. So, to sort it out, let us talk about open interest vs volume. 

Let’s consider a city bus that helps people to travel within the city. 

The total number of seats on the bus is 40 and let’s say all are occupied at the time of departure. 

Now let’s say in the first stop 5 passengers got down and at the same time, 3 passengers entered the bus. 

Thus now out of 40, 38 seats were occupied. 

On the next stop, none of the passengers got down but 2 took the bus thus again total seats booked were 40 again. 

In the third stop, 12 passengers got down and 12 entered thus there was no change in the total number of reserved seats. 

Here if we compare this number with the OI, i.e. Open Interest of the Options trading, then here the number of seats 40 is the OI and the total number of passengers who actually took the bus i.e. 57 is the volume. 

No doubt the open interest analysis helps in understanding the market trend. But how is this number related to price and volume?

Let us now understand the open interest vs volume to grab a better understanding of how these number actually helps in determining the value and demand of the option contract. 

Open Interest vs Volume Options 

As discussed from the example above, open interest and volume are two different and related terms in the options trade. 

Knowing these numbers is important as it helps in determining the liquidity and how the option contracts are going to perform. 

In simple terms, as technical indicators help in determining the stock performance, open interest and options define different parameters of the options trade. 

For example- If the open interest is increasing, that means that new positions are being formed and more money getting in the market. Also, if the volume is increasing it usually shows high liquidity. 

To understand the concept of open interest vs volume, let us now understand both concepts in detail. 

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Stock Market Volume

Volume is the number of transactions that have happened in a particular time frame. In the case of options trading, it is the number of contracts that are traded in a given frame of time. 

It is also an indicator of what type of activity is happening on that option contract on that particular day. 

Now how is the daily volume calculated? Every position created in the market, whether a buy transaction or a sell transaction, it increases the volume. 

Let us understand this with the help of an example. 

There are 4 friends Raj, Jay, Aruna, Himansh. Now they trade and create different positions. 

Raj- Buys 10 option contracts
Jay- Buys 7 option contracts
Aruna- Sells 6 option contracts
Himansh- Sells 2 Option contracts
Jay- Now Jay exits his 10 option contracts

So, the volume, in this case, will be 35. (the sum of all the trades that have happened)

Now, volume affects the price movement and also directly shows the liquidity in the market. 

If the trading volume is high, it indicates that there is high liquidity present in the market. 

So, this is a good opportunity for the traders as this means that the chances of execution of their order are comparatively higher. 

Also, if the volume is going high and it is supported by a high price also, it is usually a strong bullish signal. 

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Open Interest In Options 

When it comes to open interest, as the name suggests, it is an open position that possibly might have somebody’s interest. 

The open interest is the number of contracts that are still outstanding in the market.

Every time a new buyer and seller enter the market, the open interest increases by one. 

It will be easier to distinguish between open interest and volume when we understand this with the help of an example. 

Let’s go back to the same four friends, Raj, Jay, Aruna, and Himansh. 

Raj- Buys 10 contracts open interest now is 10.
Jay- Buys 7 option contracts Open interest now becomes 10+7= 17
Aruna- Sells 6 option contracts; OI becomes 17+6= 23
Himansh- Sells 2 option contracts;  OI becomes 23+2=25
Jay- Now Jay exits his 10 option contracts, OI decreases and comes to, 25-7= 18

On the above data, let’s now evaluate the open interest.

How is Open Interest Calculated?

As Raj entered into the trade and buy 10 contracts, then the OI becomes 10. 

With the 7 new contracts of Jay, the value changes to 17 and later 23 and 25 when Aruna sells 6 options contract and Himansh sell 2 contracts respectively. 

Later when Jay exits 10 option contracts, thus decreasing the OI value to 18. 

 

So, entering the contract either by buying or selling increases the OI while exiting the position reduces its value. This is how OI is calculated and represented on the option chain.

Now, the change in Open interest in options can show the investors’ interest. 

So, if the high open interest against the strike price, that signifies that the most number of traders are interested in it, and therefore there are more positions being created. 

This also means that there is high liquidity in the market and the chances of order execution are higher. 

On the other hand, low open interest in option gives a strong signal towards the bearish trend. But it is highly recommended to read the OI change along with other parameters like volume and price to get better analysis.

 

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Relationship Between Open Interest and Volume 

Now that the concept of open interest and volume is not looking bleak, let us understand what is the relationship between these two to understand the open interest vs volume better. 

• Usually when you look at the Open interest and volume, and if the open interest is higher than the Open interest, what does that signify? 
• Whenever a new trading day starts, the trading volume is by default set to zero. It increases only when the transactions happen. Whereas in the case of open interest, it is usually the total of the open contracts.
• Now if on a particular day, the volume is higher than the open interest, it means that something has happened in the market which has triggered excessive buying and selling. 

If the volume and open interest both are increasing, this means that it is strongly bullish. On the other hand, if the volume and open interest both are decreasing, then the trend in this will be bearish. 

Thus, these two terms are different but related to each other when it comes to determining their role in the options contract.

This makes it even more important to grab an understanding of open interest vs volume when trading options.

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Open Interest Volume Price Relationship

Now, certainly, when we are talking about the volume and open interest, the price also comes into consideration. So, whenever we are looking at the open interest, it is important that we see the price of the underlying asset as well so that a trader can make a strong decision. 

Let us understand the relationship between all these three with the help of the given data. 

• If the price, volume and open interest all are increasing, that means that money is coming into the market and the investors are showing interest. This shows a very strong bullish trend. 
• If the prices are increasing, but the volume and open interest are decreasing, then that trend is moderately bearish. 
• If the price is decreasing, but the volume and open interest are increasing, then it will be bearish. 

 

Also, the clear idea of the two gives traders an idea of the price they are paying to buy an option contract. Open interest vs volume is important for active options traders as it helps in determining the liquidity and market sentiments.

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Conclusion 

So, here considering all the above concepts, open interest vs volume simply lies in the number of outstanding contracts in the options vs the number of traders trading in those contracts.  

Both the parameters are important when you want to know the liquidity and also the action of the market. 

So, now you can easily look at the open interest and volume and strengthen your trading decision. 

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