Forward Market
• Forwards market
• Futures contract
• Future trades
• Leverage & payoff
• Margin & M2M
• Margin calculator
• Open interest
• How to short
• Nifty futures
• Nifty futures
• Futures pricing
• Hedging with futures
• Notes
12.1 – Open Interest and its calculation
We must answer one of the often asked issues, “What is Interest (OI),” “How is it different from Volumes,” and “How can we benefit from the Volumes and interest data,” before we wrap up this lesson on “Futures Trading.” In this chapter, I’ll try to respond to these queries and more. You will be able to evaluate OI data in conjunction with Volumes after reading this and use it to make better trading decisions. Additionally, I advise you to review Volumes from this point forward.
The term ” interest” (OI) refers to the quantity of futures (or options) contracts in the market at any given time. Always keep in mind that there are two parties to any transaction: a buyer and a seller. Say the seller gives the buyer one contract. On the same contract, the seller is to be short and the buyer is to be long. In this scenario, there is reportedly only one interest.
Let me use an illustration of OI. Assume there are 5 traders who trade NIFTY futures on the market. Arjun, Neha, Varun, John, and Vikram are their given names. Let’s examine their daily trading activities and track changes in interest. Please keep in mind that grasping the sequence of events below requires patience; otherwise, you risk becoming irritated.
Let’s get going.
On Monday, Arjun and Varun each purchase six futures contracts, but Neha sells all ten of them. Following this transaction, there will be a total of 10 contracts, 10 of which will be on the long side (6 + 4) and 10 on the short side, making the total interest equal to 10.
Tuesday: Neha wants to cancel 8 of the 10 contracts she currently has, and she does so. When John enters the market, she gives him 8 short contracts. You must understand that no new contracts were into the market as a result of this transaction. Transferring it from one person to another was straightforward. Consequently, the OI will remain at 10.
Wednesday: John wants to add 7 additional short positions to the existing 8 short contracts, and Arjun and Varun both decide to expand their long holdings at the same time. As a result, John sold Arjun 3 contracts and Varun 2 contracts. Note that these are 5 newly established contracts. Neha makes the decision to fill up her posts. She essentially moved two of her short contracts to John by going long on two of them, leaving Neha with no contracts left to hold.
By Wednesday night, the market had 15 long (9+6) and 15 short positions, making the overall position size (15) 15.
On Thursday, 25 contracts are sold in the market by a huge man named Vikram. In order to liquidate 10 contracts, John decides to buy 10 contracts from Vikram, transferring his 10 contracts to Vikram in the process. Varun ultimately agrees to purchase the final 5 contracts from Vikram after Arjun adds 10 more contracts from him. In conclusion, the system now contains 15 additional contracts. I would is currently at 30.
Friday: Vikram chooses to settle twenty of the twenty-five contracts he has previously sold. He then buys 10 contracts from Varun and Arjun, respectively. This implies that 20 contracts in the system were off, resulting in a 20-contract reduction in OI. 30-20 = 10 is the new OI.
I’ll keep on; hopefully, the discussion above has given you a good idea of what Interest (OI) is all about. The OI data only shows how many positions are currently available in the market. As of now, you ought to have observed this. If you provide a +ve sign to a long position and a -ve sign to a short position in the “contracts held” column then sum up the long and short positions, it always equals zero. In other words, no new wealth is ; rather, wealth is exchanged between buyers and sellers (or vice versa) (like if you hold a stock and the stock price appreciates, then everyone makes money). Because of this, derivatives are frequently referred to as a zero-sum game!
OI on Nifty futures is around 2.78 Crores as of March 4th, 2015. There are 2.78 crore Long Nifty positions and 2.78 crore Short Nifty positions, according to this. Additionally, today saw the addition of around 55,255 (or 0.2 percent over 2.78Crs) new contracts. OI is a great tool for figuring out how liquid the market is. The market is more liquid the larger the interest. Consequently, it will be simpler to initiate or exit trades at attractive ask/bid rates.
12.2 – OI and Volume interpretation
The number of open and active contracts is by open interest information. The number of trades that were on a given day is by volume, on the other hand. Volume equals 1 for every 1 buy and 1 sell. For instance, if 400 contracts were that day and 400 were sold, the volume for that day would be 400 rather than 800. Despite the numbers and open interest appearing to be comparable, they are clearly two separate things. The volume counter begins the day at zero and increases as and when new trades take place. As a result, the volume of data always grows during the day.
Take note of the daily variations in OI and volume. The volume now has no bearing on the volume tomorrow. For OI, it is not valid, though. OI and volume numbers are both essentially worthless when seen separately. However, traders frequently link these figures to prices in order to make assumptions about the market.
Contrary to volumes, the change in open interest does not really indicate a market direction. Between bullish and bearish situations, it does, however, convey a sense of strength.
Be careful if there is an unusually high OI accompanied by a sharp rise or fall in price. This merely indicates that the market is becoming increasingly euphoric and leveraged. In circumstances like this, even a minor trigger could cause significant market panic.
And with that, I’d want to put an end to this futures trading module. I sincerely hope you had as much fun reading this lesson as I did writing it!
Now let’s move on to Option Theory!
CONCLUSION
- The amount of open contracts in the market is by the term “Open Interest” (OI).
- When new contracts are added, OI rises. When contracts are off, OI falls.
- When contracts are transferred from one party to another, OI remains unchanged.
- OI is continuous data in contrast to volumes.
- OI and Volume information does not transmit information when seen independently, hence it is advisable to link them with prices in order to fully grasp the implications of each variable’s volatility.
- Extremely high OI suggests excessive leverage; avoid such circumstances.