Be it stock trading or F&O, Open Interest is one important parameter that should never ignore. We personally know several institutional traders who trade solely based on open interest without looking at any other indicators or chart patterns.
Let’s dive in and find out why it is so important.
A Quick Recap of Open Interest
As per Investopedia, “Open interest is the total number of outstanding derivative contracts, such as options or futures that have not been settled for an asset”
I’ll skip explaining the detailed calculation steps of open interest. You can find more details about it in this article.
But for all practical purposes, every strike an option chain has an individual open interest value. Open interest for a particular strike will increase if trades are happening for that strike.
For example, Open interest for Nifty 14000 CE will increase by 1 if a trader buys 1 lot of this contract, and another trader sells 1 lot. And the open interest will decrease by 1 if these traders square off their respective positions.
Reasons why Open Interest matters
Let me tell you 3 important points that prove that there is no better and confirming indicator than open interest:
- Selling an option contract require more capital, and so usually sellers are people with large capital (it also takes conviction to sell with unlimited risk)
- Buying an options contract requires less capital and the risk is limited. So most retail traders involve in buying.
- People with large capital (institutional traders) are usually right as they have enormous resources at their hand
Considering the above points, if you see a very high open interest for a particular strike, you can conclude that institutional traders are selling that strike and retail traders are buying.
And this strike will act as a resistance or support (depending on whether is a Call strike or Put strike) as institutional traders don’t want to lose money if the underlying price crosses that strike.
Also Read: Does Technical Analysis really Work?
How to Trade based on Open Interest?
Look at the options chain of the stock or index derivative and do the following:
- Find the Call strike with the highest open interest (Resistance)
- Sell that strike OR
- Sell a futures contract when the underlying price approaches that strike
- Find the Put strike with the highest open interest (Support)
- Sell that strike OR
- Buy a futures contract when the underlying price approaches that strike
- Sell both Call and Put strike with the highest open interest (short strangle) – This has the highest probability of success.
If you design your system confirming the above 3 points, you can increase your win ratio drastically. PERIOD!
Where do I find OI Data?
You can find open interest data for futures and options at several places:
- On the exchange website. For example – The option chain of NSE Nifty can be found at this link.
- On your broker dashboard, you may find OI data for every symbol in your watchlist
- Through external data feed like Truedata or GDFL, you may import historical open interest data into tools like Amibroker
- We’ve published excel based tool in the past that helps you fetch OI data from the exchange website to a spreadsheet. Find it here.
I hope you understand the importance of open interest now. It is unarguably one of the best ways to predict price movements.
Combine open interest with few technical analysis based indicators, and you’ll surely be able to build a highly accurate trading system.
Please feel free to comment if you have any questions.