Open interest

What Is Open Interest?

Open interest represents the total number of outstanding futures contracts or options contracts that have not yet been closed or exercised. It is a key metric within derivatives market metrics, providing insight into the total capital committed to a particular market. Unlike trading volume, which measures the number of contracts traded over a specific period, open interest reflects the active, unsettled positions. When a new contract is opened (a buyer and seller initiate a new position), open interest increases. When an existing contract is closed (a buyer sells to close, or a seller buys to close), open interest decreases. This metric is a crucial indicator of the overall depth and liquidity in a derivatives market.

History and Origin

The concept of outstanding positions has been inherent in commodity markets for centuries, evolving alongside the development of organized exchanges. Early forms of derivatives, such as forward contracts, existed to manage price risk for agricultural goods. The formal tracking of open interest gained prominence with the establishment and growth of centralized futures and options exchanges. For instance, in the United States, the Chicago Board Options Exchange (Cboe) played a pivotal role in standardizing and listing options contracts, starting in 1973. This standardization facilitated more transparent and trackable market data, including open interest. The Cboe's efforts, including the launch of VIX futures in 2004, helped establish volatility as a tradable asset class and paved the way for a comprehensive ecosystem of derivatives products⁸, ⁹.

Key Takeaways

• Open interest is the total number of unsettled or outstanding derivative contracts.
• It indicates the flow of capital into and out of a specific market.
• An increasing open interest suggests new money entering the market and potentially strengthens existing price trends.
• A decreasing open interest indicates positions are being closed, potentially signaling a weakening trend or profit-taking.
• It is distinct from trading volume, which measures the number of contracts traded in a period.

Interpreting Open Interest

Interpreting open interest involves analyzing its relationship with price movements to gauge market sentiment and the conviction behind a trend.

• Rising Price and Rising Open Interest: This combination often suggests a strong bullish trend, as new money is flowing into the market to support the upward movement. Buyers are initiating new long positions, indicating conviction.
• Falling Price and Rising Open Interest: This can signal a strong bearish trend. New money is entering the market, likely through new short positions, indicating conviction in the downward movement.
• Rising Price and Falling Open Interest: This scenario might indicate that the upward trend is weakening. Traders are closing out existing long positions (taking profits), rather than new money entering the market to drive prices higher.
• Falling Price and Falling Open Interest: This can suggest that the downward trend is losing momentum. Traders are covering short positions, indicating a potential reversal or exhaustion of selling pressure.

Analyzing open interest alongside price and volatility provides a more comprehensive view of market dynamics.

Hypothetical Example

Consider the hypothetical market for crude oil futures contracts.

Scenario 1: Increasing Open Interest
On Monday, the open interest for a specific crude oil futures contract is 100,000 contracts. Throughout the day, 20,000 new long positions are opened by buyers and 20,000 new short positions are opened by sellers. Simultaneously, 5,000 existing long positions are closed, and 5,000 existing short positions are covered.
The net change in open interest would be:
New positions opened: +20,000
Existing positions closed: -5,000
Thus, the total open interest at the end of Monday would be (100,000 + 20,000 - 5,000 = 115,000) contracts.
This increase in open interest, particularly if accompanied by rising prices, would suggest strong conviction and new capital flowing into the crude oil futures market, possibly indicating a robust bullish trend driven by speculation or increased hedging activity.

Scenario 2: Decreasing Open Interest
Now, imagine the open interest is 115,000 contracts. On Tuesday, 10,000 existing long positions are closed, and 10,000 existing short positions are covered. Only 2,000 new long positions and 2,000 new short positions are initiated.
The net change in open interest would be:
New positions opened: +2,000
Existing positions closed: -10,000
The total open interest at the end of Tuesday would be (115,000 + 2,000 - 10,000 = 107,000) contracts.
This decrease in open interest, especially if seen during a price decline, might suggest a lack of new interest in the market, with existing participants exiting their positions. This could signal a weakening of the current trend or a period of consolidation.

Practical Applications

Open interest is a valuable tool for investors and traders in several ways:

• Market Depth and Liquidity Assessment: High open interest indicates a deep and liquid market, making it easier for large orders to be filled without significantly impacting prices. Conversely, low open interest might suggest a thin market, leading to higher price slippage.
• Trend Confirmation: As noted in interpretation, rising open interest often confirms the strength of a price trend (up or down), as it signifies new money entering the market in alignment with that trend. Declining open interest can signal weakening momentum.
• Identification of Accumulation/Distribution: A sharp increase in open interest without a significant price movement might suggest accumulation (buyers quietly building positions) or distribution (sellers quietly offloading).
• Commitments of Traders (COT) Reports: The Commodity Futures Trading Commission (CFTC) regularly publishes the Commitments of Traders (COT) reports, which break down open interest by different categories of traders (e.g., commercial, non-commercial). These reports are widely used for technical analysis to understand the positioning of various market participants and inform trading decisions⁷. The Office of Financial Research (OFR) provides details on how these reports are compiled and the categorization of traders, offering insights into their utility for market analysis⁶.
• Options Trading: For options contracts, open interest can highlight popular strike price levels and expiration dates, which may act as areas of support or resistance for the underlying asset.
• Global Market Insights: Resources like "Reuters Open Interest" provide data-driven commentary on market and economic trends, often leveraging open interest data across various asset classes to offer insights into global financial markets⁴, ⁵.

Limitations and Criticisms

While a powerful indicator, open interest has its limitations. It provides a quantitative measure of market participation but does not inherently reveal the specific intentions behind each trade. For example, a new position could be initiated for hedging purposes by a commercial entity, or for pure speculation by a large fund. The raw number alone doesn't differentiate these motives. The Commitments of Traders (COT) reports, while categorizing traders, classify positions based on the predominant business purpose self-reported by traders, and CFTC staff do not know specific reasons for individual positions³. This means, for instance, a "producer/merchant/processor/user" category might include positions for both hedging and speculation, limiting granular analysis of intent².

Furthermore, open interest is a lagging indicator; it changes after trades have been executed and reflects the state of the market at a specific point in time (e.g., Tuesday's close for the weekly COT report). It is most effective when used in conjunction with other metrics like price action and trading volume, rather than as a standalone signal. Also, the accuracy relies on reporting by various market participants to a clearing house or regulatory body, and while robust, errors or delays can occur. Traders must also consider that a high open interest does not guarantee future price movement, nor does low open interest preclude a significant move.

Open Interest vs. Trading Volume

Open interest and trading volume are often confused but measure distinct aspects of market activity.

When a new buyer and new seller enter into a futures contract, open interest increases by one. If an existing buyer sells their contract to a new buyer, open interest remains unchanged, but trading volume increases by one. If an existing buyer sells their contract to an existing seller who is covering a short position, both open interest and trading volume increase. However, if an existing buyer sells to an existing seller who is covering a short, open interest decreases as positions net out, but trading volume increases. This is a common point of confusion. For example, if a trader with a long position closes it by selling to another trader who is initiating a new short position, the open interest remains the same because one open long position was replaced by one open short position, while the volume increases by one.

FAQs

How often is open interest updated?

Open interest is typically updated daily by exchanges and clearing houses after the close of trading. Regulatory bodies like the CFTC release weekly Commitments of Traders reports, which provide a breakdown of open interest by different trader categories¹.

Can open interest be zero?

Yes, open interest can be zero for a specific contract or expiration date if no contracts have been opened or if all previously opened contracts have been closed or exercised. This is common for newly listed contracts or those nearing their expiration date with low interest.

Does open interest predict price movements?

Open interest is not a direct predictive indicator, but it can confirm the strength of a price trend and indicate conviction. A rising open interest during a rally can confirm bullish sentiment, while a rising open interest during a decline can confirm bearish sentiment. It should always be used in conjunction with price action and other forms of technical analysis.

Is open interest important for all asset classes?

Open interest is primarily relevant for derivatives markets, such as futures contracts and options contracts on commodities, equities, currencies, and interest rates. It is not typically applied to cash markets like stocks or bonds, where liquidity is generally measured by trading volume alone.

What is the significance of high open interest at a particular strike price for options?

For options contracts, high open interest at a specific strike price suggests that many traders have positions (both long and short) at that level. This can indicate that the market views that strike price as a significant level, potentially acting as strong support or resistance for the underlying asset as the expiration date approaches.