Open interest options (OI) are a very critical component to pay attention to on an options chain. OI shows the amount of contracts that are currently open on a particular stock. It shows the amount of liquidity to be able to get in and out of the trade. Avoid trading options contracts with less than 100 open interest. Ideally, you want to trade options that have at least 1000 open interest or more because they are more liquid to trade. The higher the open interest the better.
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What is Open Interest (OI) in Options?
Open interest is the total number of options held by traders at the end of the day. You can also define it as the number of options contracts that have not expired or been exercised.
With stocks there’s a set amount of shares being traded. Options are different because people can write their own options contracts.
OI lets you know the shares that have been traded but are still open. Volume is also an important component to this.
Volume gives you the strength of market direction. Options volume and OI work together. It’s important to look for high OI when trading.
Look at open interest relative to the volume of contracts traded that day. If the oi exceeds volume on a trading day it tells you trading that option was popular that day.
Another thing oi can tell you is the liquidity of the option. If an option has a big OI it means there’s a lot of buyers and sellers.
This increases the odds of getting your orders filled at a good price. The bigger the oi the better the bid ask spread will be for you. We can’t stress enough the importance of paper trading options.
Trend Confirming
When open interest increases you know new money is flowing into the market. A result of increased open interest means the present trend continues. OI helps confirm trends.
That can mean going up, down, or sideways. If OI is declining, know that a trend is coming to an end. The market is liquidating.
A leveling off of OI is letting you the market can no longer sustain the trend. A correction or reversal is coming. Knowing how to write and sell options is key.
An increase in price and oi confirms an upward trend; while a decrease in price and OI confirms a downward trend. While a decrease or increase in price when OI stays the same tells you a trend reversal is coming.
Use this information when buying or selling a call or put.
Price Action
Price action has a lot to do with options open interest. An increasing OI shows a bullish trend; price action can tell more.
If price action is going higher but OI is falling, shorts are covering their positions. Sellers covering their positions is causing a short term rally. This is a bearish sign and means money is leaving.
If price action is down but open interest is rising; a trader will know that new money is coming into that sector/market because there are new short sellers.
OI coupled with price action can tell a lot about trends. Use the volume and OI trading strategy to find bullish or bearish plays.
If you need more help, take our options trading course.
