Two dimensions characterize the liquidity and activity contracts for options and futures markets:
1. Volume refers to the number of contracts traded in a given period
2. Open interest-the number of active contracts.
[Open interest and volume are two important concepts to understand when trading options. If you are a beginner in options trading, options questions answers for beginners is a comprehensive review of options, covering everything from risk management to advanced strategies like spreads, strangles, and hesitates.]
Trading volume measures the number of options or futures contracts that are exchanged between buyers and sellers, identifying the level of activity under this contract. For example, suppose that the volume ABC in the option with a strike price of $55 and an expiration date of three weeks does not trade any contracts on the day. Thus, trading volume is 0. In the next session, the investor buys 15 contracts a call option while the market-maker sells 15 of option contracts call, rising trading volume on that session to 15.
Open interest shows the number of options or futures contracts which are traders and investors in an active position. These positions have not been closed, expired or exercised. Open interest decreases when the owners and the authors of the options (or buyers and sellers of futures) close out their positions. To close the position, they should take offsetting positions or to perform their functions. Open interest increases again when investors and traders are opening new long positions or writers/sellers will take on new short positions. Open interest increases when we are creating new options or futures contracts,
For example, suppose that the open interest option AVS 0. The next day the investor buys 10 options and another 10 investor sells option contracts. Open interest for the option is now 10.
Options or futures the volume of trading agreement can only increase, and open interest can either increase or reduce. While trading volume indicates the number of contracts that were bought or sold, open interest determines the number of contracts that are currenltly held.
Price Vs. Open Interest
1. The growth rates in an uptrend, while the open interest is on the rise, suggests that the new money in the market (including new buyers). This is considered bullish.
2. The growth rates in an uptrend, while the open interest is on the decline indicates that short sellers covering positions. Money leaves the market, which is a bearish sign.
3. Falling prices in a downward trend, while the open interest is on the rise, suggests that the new money is coming into the market on the short side. This scenario is consistent with the continuation of the downtrend and is bearish.
4. Falling prices in a downward trend, while the open interest is on the decline indicates disgruntled owners forced to eliminate positions and it is a bearish sign. However, it may also indicate a selling climax near.
5. High open interest while the price falls sharply on the potential market indicates the bearish scenario, because the owners who bought at the top lose money, raising the potential for panic.