Derivatives Trading Basics
by 5paisa Research Team Last Updated: 2022-09-29T15:43:50+05:30

Introduction

Options are a stock market tool determined by underlying securities of the stock market. An options contract allows traders to buy or sell the underlying asset. However, holders can decide against buying or selling the assets if they choose to. But they must execute the deal before the contract expires. 
The price of options trading is influenced by the buying or selling of options by traders. It is crucial to grasp the concepts of daily trading volume and open interest to understand options trading. These factors are instrumental in interpreting the market trends of options trading. This article will delve into open interest meaning, trading volume, its implications, what is OI in options, and what is open interest in share market.

 

Daily Trading Volume

Daily trading volume refers to the number of options contracts traded in a single day. This volume is a strong marker of the strength and performance of the underlying securities. It also gives insight into the relevance of the stocks of a company and investors' preferences. 

However, the interpretation of trading value is not absolute but a relative understanding of the underlying assets. A substantial change in the options price accompanied by more than average volume trading reveals good strength in the direction of price change. However, a bulk movement in price followed by small trading volume points toward less potential in the price change. 

 

Open Interest

Options interest meaning does not simply entail buying or selling stocks. While options trading, you either create new contacts (open them) or liquidate them (close contracts). Open interest measures the total number of options contracts existing for a stock. These active options are traded but not liquidated by exercising trading rights. 

Of course, during daily trading, if the options are more open than closed, the open interest increases and vice versa. The Open Interest provides a lot of data regarding the options like volume, bid price, ask price, etc. Every options trading has two stages: buying and selling. The one who buys is supposedly long on the trade, and the one who sells is short. If one contract is being sold and bought, the OI is 1. 

Let us understand 'what is open interest' with a market demonstration.

Traders Joe, Mitch, Raymond, and Rachel are engaged in options trading, and let us analyze their daily trading activity across two days. 

First day: Raymond sells ten contracts. Joe buys five contracts, and Mitch buys five contracts from Raymond. So, simultaneously there are ten long contracts and ten short.

 

Trader

Buy

Sell

Contracts Held

Joe

           5L

 

   5L

Mitch

            5L

 

   5L

Raymond

 

10S

10S

Open Interest

 

 

10

 

Second day: Raymond transfers six6 contracts to Rachel. So, Rachel takes on six short contracts from Raymond. Since there are no new contracts created, the OI remains the same. 

Trader

Buy

Sell

Contracts Held

Joe

   

5L

Mitch

   

5L

Raymond

6L

 

4S

Rachel

 

6S

6S

Open Interest

 

 

10

 


So, OI indicates the open options in the market. Please note that the sum of the long and short options will always be zero. To understand it better, assign a positive sign to long positions and a negative sign to short options. 

 

Why does Open Interest Matter? 

Open Interest does not relay the information if the options were bought or sold but provides valuable information regarding options trading. To comprehend 'what is OI in option chain,' we must look at the benefits of using it. 

● It offers a relative understanding of market trends when coupled with trading volume. If the trading volume exceeds the OI in a day, it indicates that trading in that option was high in the given time frame.
● Open Interest increases when contracts are added to options trading and decreases when options are closed. 

● The OI also indicates if there is any availability of a secondary market. High OI reveals that there is a large number of traders interested in the options of the company. The more active the secondary market, the better the chances of fulfilling options trading at better rates.

● Another information OI conveys is that a high OI implies a greater liquidity opportunity for the options contract. When there is a mutual interest in selling options and buying them, there will be little difference between the price someone wants to sell and the price a trader wants to buy. Thus, the more extensive the OI, the more reasonable the negotiations between the ask and bid price of the options will be. 

● While dealing with options, it is crucial to remember that OI does not forecast a bullish or bearish market. A high open interest does not always mean a stellar company record and growth. People trading in high numbers in option trades might have made wrong forecasts on the stock market. Hence, beware if the OI is astronomically high since it might indicate high volatility. 

 

The Bottomline

Investments and trading can be tricky businesses, especially for beginners. However, knowing the strategies and activities of other investors can help inform your trading game. Denominators like trading volume and OI are the market indicators that help understand market performance and identify investment opportunities. Open Interest and Daily Trading Volume may not be enough to understand the potential of underlying assets on their own, but a combined study gives proper insight into price changes.

Daily trading volume gives insight into the options trading activities of the day of a particular stock. At the beginning of the day, the trading volume starts at zero and builds up during the day with new transactions. OI, on the other hand, indicates the number of outstanding stock options. Of course, these market indicators change every day. Please note that you can track trading volume on a particular choice throughout the day, but OI is only known the next day when The Options Clearing Corporation posts it after all calculations. 


 

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