What is Open Interest in Stock Market?

Open interest refers to the total number of active derivatives, like futures or options, that remain open and unsettled at the end of a trading session. It is created whenever a new buyer or seller enters a trade and is closed only when one party exits, or the contract expires. Open interest in stock market is used to calculate the level of market participation and liquidity in a particular security or contract. If there is an increase in the open interest, then it indicates that new positions are being added, while a decrease shows existing positions are being closed. Traders study the open interest to evaluate the trend strength, potential reversals, and the flow of capital in derivatives trading. This article explains what is open interest in share market, how it works, and more.  

Example of Open Interest 

Let’s assume there are three traders, A, B, and C. They all are trading the same futures contract.  

On day 1, trader A enters a new long position by purchasing three contracts from trader B, who takes a new short position. As both traders are opening new positions, the open interest will increase by three contracts.  

On day 2, trader C enters the stock market and sells five contracts to trader A. Among these, three contracts will close A’s existing position, whereas two contracts may create new positions. This results in the rise of open interest with only two contracts.  

On day 3, trader B exits part of the position by purchasing two contracts from trader A, who also closes that portion. Since existing positions are getting closed on both sides, open interest may decrease by two contracts.  

After understanding open interest meaning, this article further provides the benefits of monitoring open interest in share market. 

 How Does Open Interest Work? 

Open interest works by counting how many active derivative contracts exist in the market at a given time. It changes only when a contract is created or closed, not when traders simply exchange an existing contract. 

Step 1: Two Parties Place Opposite Orders: The trade begins when two parties place opposite orders like one trader may want to buy a futures/options contract (long). Whereas another trader wants to sell that same contract. 

Step 2: The Exchange Matches the Orders: Once the exchange matches the order, a contract is formed between the two parties through the exchange/clearing system. 

Step 3: Open Interest Increases : When a new contract is created, the open interest rises because if the buyer is opening a new position and the seller is also opening a new position, then a new contract is created. 

Step 4: Existing Positions May Change Hands: Open interest stays the same when an existing position is transferred. So, if one side is opening a position but the other side is closing an old position, no new contract is created overall. The open interest remains unchanged here.  

Step 5: Open Interest Decreases : If both the buyer and seller are closing their existing positions, the contract is removed from active positions. The open interest falls by 1 contract. 

Step 6: Open Interest Resets : The open interest resets when, at expiry the contracts are settled. If there are any remaining open contracts they get removed.  

Benefits of Monitoring Open Interest 

Here are the benefits of monitoring open interest: 

• A few conclusions can be drawn about the day's activity by watching the change in open interest figures at the end of each trading day. 
• An increase in open interest indicates that new money is flowing into the market. Thus, the current trend will continue (up, down, or sideways). 
• Whenever open interest declines, there may be a liquidation in the market and the current price trend may be coming to an end. It can be useful to know open interest toward the end of major market moves. 
• Often, a levelling off of open interest after a sustained price advance signals the end of an uptrend. 

Differences Between Open Interest and Trading Volume 

The table below shows the difference between open interest and trading volume.  

Disclaimer: All investments are subject to market risks, economic conditions, regulatory changes, and other external factors. Returns are not guaranteed and may vary based on market performance and investment tenure. Investors should assess their risk of tolerance and financial objectives, conduct their own research, and consult a qualified financial advisor before making any investment decisions.   

Conclusion 

Open interest represents the total number of active futures and options contracts that remain open in the market at any given time. It helps traders understand whether new positions are being created or existing ones are being closed. By carefully analysing the changes in open interest along with price and volume, traders can easily understand the trend of strength, market participation, and possible reversals. When used through an online trading app, open interest becomes a practical indicator for making informed decisions in derivatives of trading and overall market participation.