"Does Open Interest Affect The Market?"

"Does Open Interest Affect The Market?"

"what is open interest?? if Open interest created on the market, what does mean it ? market will go uperside or downside??"
- Asked By Himadri on 29 December 2008

Answered by Mr. OppiE

Hi Himadri,

Open interest is the options trading market's way of recording how many options contracts are there floating around in the market. When an option trader creates a new options contract and sells it in the options market to a buyer, open interest increases by 1. When that buyer exercises that options contract or sells it away, open interest decreases by 1.

To understand open interest, you need to think of options contracts as commodities or goods. The OCC (Options Clearing Corporation), which oversees the options market, keeps track of how many commodities are available in that marketplace by calling it Open Interest.

For example, when you buy to open 5 contracts of call options, the open interest of those call options increases by 5. This is because the sellers, who really are market makers, created new call options contracts and sold it to you, increasing the inventory of options contracts in the marketplace by 5. When you sell those call options contracts or exercise them, market makers take those call options back from you and hence from the marketplace and open interest reduces by 5.

In actual fact, that is all open interest mean. It only indicates how many open positions there are of each options contract in the options market. It is not a number that tells you whether the market will go up or down. However, it does give you an indication on the liquidity of the options contract that you are going to trade and also tells you whether more people have traded call or put options and still holding those positions.

So, does it mean that a stock is going to go up if it has more open interest on its call options than put options? Not at all. What open interest does not tell you is whether the open position is a short or long position. Options traders who think the stock is going to go down could open a short position on its call options and still increase the open interest of its call options.

In conclusion, open interest may be able to provide an indication on the liquidity of a stock's options contracts but it definitely isn't a mathematically proven indicator of where a stock or the market is going to go. Please read the tutorial on Open Interest for a complete idea of what open interest is.

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