What is Open Interest in the Share Market?

Understanding Open Interest in Share Market

"Open interest" refers to the total number of open contracts market participants hold after a day. It can also be referred to as the overall number of futures or option contracts that still need to be executed, expired, or completed by delivery.

In particular, open interest applies to the futures market. Open interest, or the total number of open contracts on the security, is often used to confirm trend reversals in futures and options contracts. Money flows into the futures market are measured as "open interest." There must be a buyer of that contract for each seller of a futures contract. Thus, only one contract is created by the seller and buyer.

Therefore, we need only know the totals from one side or the other, buyers or sellers, not the sum of both, to determine the total open interest in any given market. The number of contracts on a day shall be shown as an increase or decrease in the Open Interest position, which is notified each day and will be presented positively or negatively.

How is Open Interest Calculated?

Open interest is calculated for a specific derivative contract by summing up the total number of long and short buy and sell contracts. There are long-side buyers and short-side sellers in every futures or options contract. Open interest will increase when a new contract is entered into between the purchaser and the seller. Open interest shall be reduced by one when an existing contract is replaced by the seller's and buyer's closing of positions.

Example of Open Interest

Consider an example of calculating open interest on futures contracts, the common area where open interest can be applied.

Example: Suppose you follow a futures contract for "XYZ" in the stock market. There are 100 shares of Stock XYZ for each futures contract.

Let us calculate the open interest for each day:

Day 1:

• The purchase of Trader A increases open interest by 5 contracts.
• 3 contracts have been taken off the Open Interest by Trader B's sale.
• Open interest on Day 1 is (5 - 3) = 2 contracts.

Day 2:

• The purchase of trader C has resulted in 2 contracts being opened for interest.
• The sale by trader A results in a reduction of 1 contract's outstanding interest.
• Open interest on Day 2 is (2 - 1) = 1 contract.

Day 3:

• 4 open interest contracts are added to Trader D's purchase.
• Open interest is multiplied by 2 contracts when trader B buys to cover his short position.
• Open interest on Day 3 is (4 + 2) = 6 contracts.

So, the open interest for the Stock XYZ futures contract is 2 contracts on Day 1, 1 on Day 2, and 6 on Day 3. An open interest is helpful for understanding the level of liquidity on the market. Greater open interest will make it easier to trade and exit at competitive bidding or asking rates, because the market is more liquid.

Importance of Open Interest

Open interest is used to measure market activity. There are no openings, or nearly all positions are closed because of little or no open interest. High open interest means several contracts remain negotiated, and market participants will pay close attention to these markets.

Open interest refers to money flowing into or out of a futures or options market. Open interest refers to new or additional money that comes into the market, while lower open interest indicates outflows from the market. Open interest is essential to options traders as it provides vital information on option liquidity.

Benefits of Monitoring Open Interest

Open interest has several benefits. You can monitor and know different changes in the stock market. Evaluate Open interest to gain & take different advantages which are as follows:

1. New funds flow to the market as open interest increases. This will lead to the continuation of the current upward, downward, or sideways trend.

2. The decrease in open interest shows the market's decline and indicates that the price trend has ended. In particular, open-interest knowledge can be helpful in reaching the end of significant market movements.

3. After a prolonged price gain, a leveling off of open interest is frequently a sign that an uptrend or bull market is ending.

Conclusion

Open interest is the total number of open derivative contracts that have not yet been settled. They are still not used, finished, or run out. This measure is linked to the options and futures markets rather than the stock market. Instead of adding up all of the transactions between buyers and sellers, open interest is based on the total number of open contracts. Open interest is typically not used as a trend or price movement indicator. If you plan to keep taking steps into futures and options trading, go ahead with the Kotak Securities app and get tons of tools & insight on stock market trading.