Open Interest vs. Volume: An Overview

Volume and open interest are two key measures that describe the liquidity and activity of contracts in the options and futures markets. However, their meanings and applications are different. Volume refers to the number of contracts traded in a given period, while open interest denotes the number of contracts that are open or active. Here's a more detailed look at the two measures and how investors can use them to understand trading activity in the derivatives markets better.

Volume

Trading volume is updated throughout the trading day and measures the number of options or futures contracts being exchanged between buyers and sellers, identifying the level of activity for that particular contract. For every option that is bought and sold, the transaction itself counts toward the daily volume, regardless if the trade is an opening or closing transaction.

Key Takeaways

  • Volume and open interest both describe the liquidity and activity level of contracts in the options and futures markets.
  • Volume refers to the number of trades completed and is, therefore, a key 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.
  • While volume is running total throughout the trading day, open interest is updated just once per day.

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.

Investors sometimes see volume as an indicator of the strength of a price move. The higher the volume, the more interest there is in the security. The higher volume also means that there is greater liquidity in the contract, which is desirable from a short-term trading perspective, as it means there is an abundance of buyers and sellers in the market.

Open Interest

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 (either buy or sell) not been closed out, expired, or exercised. Open interest, which is updated just once per day, decreases when buyers (or holders) and sellers (or writers) of options (or buyers and sellers of futures) close out more positions than were opened that day.

To close out positions, a trader must take offsetting positions or exercise their options. Open interest increases once again when investors and traders open more new long positions or writers/sellers take on new short positions in an amount greater than the number of contracts that were closed that day.

For example, assume 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 increases by five to 15.

Volume and open interest are sometimes used in technical analysis, as the numbers provide information about the buying or selling interest underlying a potential price move. However, one must also look further at whether the open interest is in calls or puts, and whether the contracts are being bought or sold.

Special Considerations

1. Rising prices in an uptrend while open interest is on the rise indicates that new money is coming into the market (reflecting new positions). This can be considered a sign of bullish sentiment if the increase in open interest is being fueled by buying or long positions.

2. Rising prices in an uptrend while open interest is on the decline could indicate that money is leaving the marketplace; this is a bearish sign.

3. 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 downtrend continuation and is bearish.

4. Falling prices in a downtrend while open interest is on the decline possibly indicates that disgruntled holders are forced to liquidate positions and is a bearish sign. However, it can also indicate that a selling climax is near.

5. High open interest while prices drop sharply at a potential market top could be a bearish scenario if holders who bought near the top are now losing money, raising the potential for panic selling.