Open interest is the total number of outstanding options contracts that have not been settled for an asset. Open interest provides an accurate picture of derivative trading activity including whether money flowing into options markets are increasing or decreasing.
To understand open interest, we must first explore how options contracts are created. If an options contract exists, it must have had a buyer. For every buyer, there must be a seller since you cannot buy something that is not available for sale. The relationship between the buyer and seller creates one contract. The contract is considered "open" until the counterparty closes it. Adding up the open contracts, where there are a buyer and seller for each, results in the open interest.
Why is knowing open interest important?
- Open interest is a measure of the flow of money into options markets. If open interest is increasing, this represents new or additional money coming into the market while decreasing open interest indicates money flowing out of the market. While this isn’t indicative of whether or not the trades will be profitable, it is a good measure of interest in the market or more specifically, a particular instrument.
Can open interest be used as an indicator of market momentum?
- Yes. Since open interest represents additional money and interest coming into a market, it is generally interpreted to be an indication that the existing market trend is gaining momentum or is likely to continue.