Open Interest

Definition

Open interest refers to the total number of outstanding derivative contracts, such as futures and options, that have not been settled. It indicates the market activity and liquidity of a particular contract. The higher the open interest, the easier it is to buy or sell options or futures contracts.

Phonetic

The phonetics of the keyword “Open Interest” is: /ˈoʊpən ˈɪntɹɪst/

Key Takeaways

Open Interest refers to the total number of outstanding derivative contracts, such as options or futures that have been, but not yet been settled. Here are three main takeaways about open interest:

1. Measure of Market Activity: Open interest represents the total level of activity into the futures market. A rising open interest number indicates that the present trend is gaining momentum, while a decreasing open interest indicates a weakening trend.
2. Insight into Market Direction: Increases or decreases in open interest can be used to confirm price action. A high open interest in a bull market shows that investors are expecting upward price movement, while high open interest in a bear market points to lower price levels.
3. Liquidity Indicator: High open interest means greater market liquidity, thus a higher probability for orders to be executed quickly. Lower open interest might result in difficulty entering or exiting market positions at optimal prices.

Importance

Open Interest is a significant term in the field of business and finance as it reflects the total number of open or outstanding contracts in a particular market, that haven’t been settled. It provides necessary insights to investors and traders regarding the liquidity, market activity, and potential reversals in the price movement. A high level of open interest signifies an active market with a large number of participants, which leads to better price efficiency. Furthermore, changes in open interest can predict price trends. Therefore, understanding open interest helps market participants gauge market sentiment, manage risk, and make informed trading decisions.

Explanation

Open Interest is primarily used to gauge the market’s liquidity and activity level. It serves as a critical indicator in financial markets, functioning as an accurate measure of the flow of money into a particular market. For example, when open interest in a futures contract is high, it suggests that the flow of money into that contract is significant. This hints at a well-liquidated market, which, in turn, makes it easier for traders to enter or exit positions without causing a significant shift in the price. Therefore, an increase in open interest represents improved liquidity and more activity, favoring large-volume traders.Additionally, open interest is used to determine whether money is flowing into or out of a contract and thus to infer the potential future trend of its price. The movement in open interest can be seen as a signal of the strength behind the price moves. For instance, when both price and open interest are increasing, it might suggest the arrival of new money to support the ongoing trend, potentially implying that the existing price trend is likely to continue. Therefore, traders and analysts often look at open interest with the price to confirm the strength of a trend, a process known as price-volume-open interest analysis. This approach helps gain a more in-depth insight about market trends and make more informed trading decisions.

Examples

1. Futures Trading: In the world of futures trading, open interest signifies the total number of contracts, whether long or short, that are yet to be settled. For example, if Trader A buys 5 futures contracts from Trader B who is the seller, the open interest of that particular futures product increases by 5.2. Options Trading: Open Interest is a common term used in options trading. For instance, if on a particular day in the stock market, 10 options contracts of company XYZ are bought, and none are sold, the open interest will be 10. If the next day, 5 more contracts are bought, and none are sold, the open interest for the options of company XYZ will increase to 15.3. Commodity Markets: Open interest concept is also used in commodity markets indicating the number of contracts that are active or open for a particular commodity. For example, if the open interest for wheat contracts in a particular month is high, that means many traders are interested or invested in that commodity’s futures, showing a trend or prediction about the price direction of that commodity in future.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Derivatives
• Option Contracts
• Volume
• Settlement Price
• Short Position

Sources for More Information

• Investopedia
• Nasdaq
• The Balance
• The Commodity Futures Trading Commission (CFTC)