Option trading using open interest

This can be summarized in the following table:. For those of you who are familiar with volume, the interpretation of open interest movements along with price are very similar to volume. Just as when price goes up on rising volume, it is a bullish sign; so it is with open interest.

In fact, here are the rules for trading with open interest:. With the introduction of intraday data for futures and options in Investar, you can now use the intraday screener to scan all the NSE futures for those futures that are gaining on high open interest in intraday specifically in 5-min, min, min and min timeframes.

This can give an additional confirmation, e. Open interest also gives you key information regarding the liquidity of a future or option. If there is no open interest for an option, there is no liquidity for that option.

When options have large open interest, it means they have a large number of buyers and sellers, and hence more liquidity and this will increase the odds of getting option orders filled at good prices. So, all other things being equal, the bigger the open interest, the easier it will be to trade that option at a reasonable spread between the bid and ask.

Volume for a futures contract is simply the number of contracts that have been traded on a particular day. If you subsequently close that position by using the sell to close order, they could be sold back to the writer and therefore cease to exist.

This would cause the open interest to go down. When you place a sell to open order, you are writing new options contracts to be sold so the open interest would go up. If you later chose to place a buy to close order on those same contracts, you would be closing your position by buying them back and it would go down. As you can see, the number of options contracts in existence can vary depending on what trades are being made but, in any given day the open interest of an options contract can fluctuate quite dramatically.

It's calculated at the end of each day rather than in real time, so whenever you see it quoted it would be accurate up until the end of the previous trading day. Conversely, a number of traders over value the importance of it, believing it's the sole indicator of the liquidity of the contract. The truth is actually somewhere in the middle. It's certainly relevant, but it's only one of three indicators of liquidity. The liquidity of options contracts is very important to traders.

Liquidity gives you an idea of how easily specific options can be bought and sold at the market price. Highly liquid ones are generally easy to buy and sell, and orders will be filled quickly. Ones with low liquidity, on the other hand, aren't necessarily that easy to trade. Ideally, you want to be trading ones with a high liquidity to ensure that you can enter and exit positions with relative ease. That is where the largest open interest happened to be.

Since prices opened above this range in the morning, traders should have been looking for opportunities to short the ETF until it settled into the range suggested by the open interest.

So, what can a retail trader do about this pinning? Recognize that it does happen and either stay out of the market or trade the momentum. Trading this can be very risky as you need to be quick in your decision to enter and exit when the momentum is slowing, not reversing. It is not for everyone, but if you are prepared you may be able to profit from this pinning that occurs in the markets every expiration day. Watching the potential pinning activity in the week before option expiration and also the open interest on the weekly options can also assist those traders looking to make profits on short-term swing trades as well.

Trades should only be entered based on supply and demand zones. The open interest information provided here is only a decision support tool. To learn how to identify the zones accurately and efficiently, visit your local Online Trading Academy office today.

Disclaimer This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader.

The author may or may not have positions in Financial Instruments discussed in this newsletter.