What is Open Interest?

Key Highlights:

• What is Open Interest?
• The Calculation
• Relation between Asset Price and Open Interest

What is Open Interest?

Open Interest is the total number of outstanding contracts that are held by market participants and applies primarily to the exchange market.

The basic rule is, for each buyer of a contract there must be a seller. From the time the buyer or seller opens the contract until the counter-party closes it, that contract is considered 'open'.

In case of USDINR, one can track the Open Interest on NSE Currency Futures or MCX Currency Futures Platforms.

The Calculation:

#1 lot =1000 USD

To understand, how the Open Interest is calculated, let us have a look a look at the above demonstration.

One day one, Mr. A buys 10 lots from Mr. B and the Open Interest of the underlying becomes 10. The next day, Mr. C buys 5 lots from Mr. D and the Open Interest rises to 15. On Day 3, Mr. A unwinds his position by selling 5 lots to Mr. D, who already had a sell position earlier. Thus the Open Interest falls to 10 lots. On Day 4, Mr. A unwinds another 5 lots by selling the same to Mr. E, a new entrant, and so the Open Interest remains unchanged. The net positions at the end of day 4 will be as follows:

Asset Price vs. Open Interest:

In Scenario 1: The Scenario is an example of fresh long position by the markets players. If in the uptrend, the prices are rising along with rise in open interest, it is interpreted as new money coming into the market and the same is considered to be bullish.

In Scenario 2: This scenario is an example of fresh short position by the markets players. If in the downtrend, the prices are falling along with the rise in open interest, it is interpreted as that new money is coming into the market, showing aggressive new short selling.

In Scenario 3: The Scenario is an example of long unwinding by the markets players Now, if the total open interest is falling and prices are declining, the price decline is likely being caused by profit booking in the long position holders. This suggest short term top is in place which could be reversal in the trend or short term consolidation in the asset prices

In Scenario 4: The Scenario is an example of short covering by the markets players. Lastly, if the price action is rising and the open interest is on the decline, short sellers are covering their positions, causing the rally. This suggests short term bottom is in place which could be reversal in the trend or short term consolidation in the asset prices.

Conclusion:

It is important to understand that studying only the Price movement would give incomplete information, by monitoring the Open Interest, one is able to better gauge the buying or selling pressure behind the movement. This information can be used to confirm a price move or warn that a price move is not to be trusted.

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