What is Open Interest?
Let’s get the basics out of the way, dear trader. What exactly is open interest?
Open interest is a fairly straightforward metric, actually. It refers to the total volume of options available to be traded at a given time. As you can guess, this number is in constant change throughout the day as traders buy and sell contracts. Open interest can be used as a broad measure of market liquidity, with high open interest indicating the market is deep and ripe for trading. It’s important to not confuse this with volume – which represents the number of options contracts actually traded in a market. Open interest, on the other had, represents contacts available for settling.
Open interest is a good indicator of volatility, with high open interest signaling that market participants expect the market to make a significant move in the near future. When viewing an options or futures quote, open interest is usually shown along with the current price (bid, ask, and last) and volume, which helps you provide a proper evaluation of the contract.
How Is Open Interest Calculated?
Since open interest is a measure of the number of contracts that have been traded over a given period of time, it is denoted by value of all options contracts currently held by investors in the market. The number of options by investors who have closed their contracts (not transferred them to another party) does not count, since those contracts no longer exist.
Here’s an example:
- Let’s say a buyer and seller trade an options contract between each other of say, 50 BTC at a strike price of, say, $35700.
- Now, the open interest will increase by 35700 x 50 = $178,500.
- Now this buyer may sell the contract to another buyer. In such a case, the open interest will remain the same since merely its ownership has been transferred.
- For every such buyer and seller, open interest will only go up once new contracts are traded, not transferred.
Open interest is a useful tool for analyzing the options market, as it provides a snapshot of the level of activity in a given market and can be used to gauge the level of interest in a particular asset. It can also be used as a screen to identify over or under-valued options, which may provide opportunities to capitalize on the market.
How is Open Interest Analyzed?
Open interest is often used to confirm price trends in the market, an increase in open interest strength is typically confirmation of the trend, and a decrease is a signal that the trend is losing strength. The basic idea behind it is that the more traders enter the market, the higher is the open interest; showcasing the trader’s confidence in that particular asset.
One of the most common ways to analyze open interest in a crypto option is to use the open interest to the total options in the market as a percentage. For example, if 10% of the total options in the BTC market are held by investors, then 10% of the open interest is held by investors. This is a useful metric for identifying when the majority of options in the market are held by a few investors. However, this metric can be misleading if used in isolation.
Why is Open Interest Important?
With a thorough analysis of the open interest of a particular crypto asset, traders can understand what the market’s most favored tokens are. With the daily volume, you can get a sense of the short term support and resistance of the crypto asset, too. The largest put options will be the support, and the highest call strike will be the resistance for the market.
The Open Interest metric is an important indicator of the health of an options market. High levels of open interest indicate that there are a large number of options available to trade, which in turn indicates a high level of liquidity. Low levels of open interest indicate that there are a limited number of options available to trade, which in turn indicates a low level of liquidity. Open interest is often used in conjunction with the Price of an option to determine the returns generated by an options trade.
Conclusion
Open interest represents the total number of contracts currently held by investors in a particular option. It is the best indicator of market sentiment and direction. The more contracts that are held in a particular direction, the higher the implied volatility and the more expensive the option. Open interest is one of the best predictors of price direction. When paired with other analytics such as trade volumes, volatility, and others, your market predictions will always be spot on.
FAQs
- What are options?
Options are a financial product that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a set price within a given time period. They are a contract between an investor and a broker which details the terms of the agreement. The price and timing of the option are determined by the buyer at the time of purchase.
- What is open interest?
Open interest refers to the value (or number) of options contracts that have been entered into but not yet closed. It is a good indicator of the level of activity in the options market. The greater the open interest, the more active the market. Open interest also provides a general sense of the market’s expectations for the underlying security.
- Is open interest enough to make a decision?
No, using just open interest to analyze the market is a bad move. On its own, it only tells you about the number of contracts that are in open positions. It does not give information about price movements or whether other trades are in a long or short position.
