Volume vs. Open Interest: An Overview
Volume and open interest are two key technical metrics that describe the liquidity and activity of options and futures contracts. "Volume" refers to the number of contracts traded in a given period, and "open interest" denotes the number of contracts that are active, or not settled. Here, we examine these two metrics and offer tips for how you can use them to understand trading activity in the derivatives markets.
- Volume and open interest both describe the liquidity and activity of options and futures contracts.
- Volume refers to the number of trades completed each day and is an important measure of strength and interest in a particular trade.
- Open interest reflects the number of contracts that are held by traders and investors in active positions, ready to be traded.
- Volume reflects a running total throughout the trading day, and open interest is updated just once per day.
- Traders use changes in volume and open interest to gauge the liquidity of the market and to anticipate price movements.
In the stock market, the volume represents how often shares change hands between buyers and sellers. For options markets, the volume metric tabulates the number of options contracts bought or sold in a given trading day; it also identifies the level of activity for a particular contract.
Each transaction—regardless of whether it's an opening or closing transaction—counts toward the daily volume.
The greater the volume, the more interest there is in the security. Investors sometimes view volume as an indicator of the strength of a particular price movement. More volume also means that there is greater liquidity in the contract; this is desirable from a short-term trading perspective, as it means that there is an abundance of buyers and sellers in the market.
For example, assume the volume in call option ABC with a strike price of $55 and an expiration date in three weeks did not trade any contracts on a specified day. Therefore, the trading volume is 0. In the next session, an investor buys 15 call option contracts, and there are no other trades that day, the volume is now 15 contracts.
The volume and open interest metrics provide information about the level of buying and selling underlying a potential price move. However, in technical analysis, one must also examine whether the open interest is in calls or puts and whether the contracts are being bought or sold.
Open interest is the number of options or futures contracts that are held by traders and investors in active positions. These positions have been opened, but have not been closed out, expired, or exercised. Open interest decreases when buyers (or holders) and sellers (or writers) of contracts close out more positions than were opened that day.
To close out a position, a trader must take an offsetting position, or exercise their option. Open interest increases once again when investors and traders open more new long positions or sellers take on new short positions in an amount greater than the number of contracts that were closed that day.
For example, assume that the open interest of the ABC call option is 0. The next day an investor buys 10 options contracts as a new position. Open interest for this particular call option is now 10. The day after, five contracts were closed, 10 were opened, and open interest increased by five to 15.
Technical analysts use open interest, along with other metrics, to gauge the strength of a market trend. Increasing open interest indicates that new traders are entering the market, and may be used to confirm a current market trend. Declining open interest shows that traders are closing their positions, and the current trend may be weakening.
Below we cite a number of scenarios that incorporate the volume and open interest indicators and ascribe to them some possible interpretation.
- Rising prices during an uptrend while open interest is also on the rise can mean that new money is coming into the market (reflecting new positions). This could be a sign of bullish sentiment if the increase in open interest is being fueled by long positions.
- If, however, open interest is on the decline while prices are rising during an uptrend, that could indicate that money is leaving the marketplace, which would be a bearish sign.
- Falling prices in a downtrend while open interest is on the rise might suggest that new money is coming into the market on the short side. This scenario is consistent with a continuing downtrend and is bearish.
- But, falling prices in a downtrend while open interest is on the decline could indicate that holders are being forced to liquidate their positions, which would be a bearish sign. This scenario also could mean that a selling climax could be on the near-term horizon.
- If there is a high level of open interest while prices are dropping sharply during a market top, it could be a bearish signal if holders who bought near the top are now losing money; this also could potentially cause an environment of panic selling.
What Is an Option Chain?
An option chain, or options matrix, is a table of all the available options on a particular security. An option chain shows all the listed calls and puts within a specific maturity date, sorted according to factors like their strike price, expiration date, and volume and pricing information.
How Much Volume and Open Interest Should an Option Have?
Generally speaking, a high volume and high open interest both indicate a liquid market with many buyers and sellers for a particular option. Changes in open interest and volume can also be used to confirm market sentiment. For example, a rising price with increasing volume and open interest indicates that the market for an option is strong, while a rising price with decreasing volume and open interest suggests a weak market.
What Does It Mean When the Volume Is Higher Than the Open Interest?
If an option has high volume and low open interest, there is a limited secondary market for that option, meaning that there may also be low liquidity. A trader trying to sell that option might have difficulty finding a buyer, or they might encounter a larger-than-usual bid-ask spread.
What Does a High Open Interest Mean?
A high open interest indicates that a large number of traders have taken active positions in an options or futures contract. If open interest increases over time, that means that new traders are entering positions, and money is likely entering the market. If open interest declines over time, that is a sign that traders are starting to close their positions.