Open Interest in Options: A Key Trading Strategy

Introduction

In the options trading environment, the rapid information flow requires the understanding of certain unsophisticated indicators, like Open Interest (OI), which from the perspective of market psychology, gauges the level of engagement from the market participants.

This blog aims to explain in simpler terms the options open interest, the mechanisms of which will guide the trader towards a successful options trading strategy.

If you're new to the derivatives market, we recommend starting with our Complete Guide to Futures and Options Trading in India. This guide explains the basics of F&O trading, contracts, and leverage. It will be simpler to understand how Open Interest works as a crucial component of sophisticated options strategies if you are aware of that foundation.

What Is Open Interest in Options? Open Interest Explained

Open Interest is defined as the total value of outstanding option or futures contracts that are still to be closed, settled or fulfilled.

Open interest displays how many option positions (buy or sell) are “open” in the market.

It grows when more positions are added, and when the contracts are closed, it decreases.

 

Example- If 10 traders each buy a Nifty 24,000 Call Option, the Open Interest (OI) is valued at 10.

If 5 traders sell their contracts, the OI will reduce to 5.

 

 

What is the Difference Between Volume and Open Interest?

 Volume and Open Interest are not the same thing, despite what some new investors believe.

 

Parameter	Volume	Open Interest (OI)
Definition	Number of contracts traded during the day	Total active contracts not closed
Changes	Resets daily	Cumulative (updates in real-time)
Indicates	Market activity	Market sentiment & trader positioning
Resets	Yes, every day	No, until expiry

 

Simply put, volume = daily activity and open interest = total active positions still in the market.  

 

How Is Open Interest Calculated?

Every time a buyer and seller finalise an options contract, open interest increases by one. If the buyer and seller close their positions, open interest decreases by one. Open interest doesn't alter if a deal is just moved from one trader to another. Open interest, a direct indicator of market activity, so displays the number of active traders holding positions.

Why is Open Interest Important in Options Trading?

 Analysing options open interest allows traders to understand market activity and adjust their trades accordingly.  

 

Here’s how:  

1. Market Sentiment Indicator  

    Rising OI + Rising Price → Sentiment is Bullish.  

    Rising OI + Falling Price → Sentiment is Bearish.  

    Falling OI + Rising Price → Short covering.  

    Falling OI + Falling Price → Long unwinding.  

 

2. Liquidity Indicator  

 More active contracts translate into improved liquidity when OI is high. Less active contracts translate into tighter liquidity and a higher risk of slippage when OI is low.

 

3. Support and Resistance Zones

 When there's a lot of Open Interest (OI) for Call Options at a specific strike price, that price acts as a resistance level.  

When there's a lot of Open Interest (OI) for Put Options at a specific strike price, that price acts as a support level.  

Such information indicates possible trend reversals or consolidation.  

 

Open Interest in Options: How to Analyse It?

Let's take a look at sample data to understand how to analyse open interest for options.  

 

Price Action	Open Interest	Market View	Trader’s Action
Price ↑, OI ↑	New long positions	Bullish	Go long or hold
Price ↓, OI ↑	New short positions	Bearish	Go short or hedge
Price ↑, OI ↓	Short covering	Bullish	Exit shorts
Price ↓, OI ↓	Long unwinding	Bearish	Exit longs

 

This simple 2x2 matrix is the core of any open interest analysis in derivatives.

 

 

 

Using Open Interest in Trading Strategies

 

1. Determining the Market Direction

 Using Open Interest to determine the direction of the market. Knowing whether or not the price change is the result of strong interest is crucial:

• If the price increases and Open Interest increases → the price change is genuine and buying interest is present.

• If the price increases and Open Interest decreases → the price change is temporary.

 

2. Anticipating Breakouts

 When Open Interest increases significantly at certain strike prices (particularly around whole numbers), this suggests important support or resistance levels. When a breakout occurs, and Open Interest increases, this validates new momentum.

 

3. Identifying Trend Reversals

A sudden decline in Open Interest, after it has been steadily increasing, may indicate trend exhaustion and a possible reversal.

 

4. Using OI in Congested Areas

 Professional traders use open interest, volume, and price action to assess the strength of the trend prior to making a trade.

 

Using Open Interest Data in Real Life

 

1. Visit the BSE or NSE Derivatives Section

 Open Interest data for Calls (CE) and Puts (PE) is available on the NSE Open Interest "Option Chain" page.

 

2. Determining Max Pain

 The strike price that has the highest cumulative OI (Calls + Puts) will come close to determining where the market will land at expiry.

 

3. Daily Tracking of OI Changes

 Rapid rises in Open Interest (OI) may indicate potentially new positions being established, signalling expected volatility on the horizon.

 

4. Combine with Other Technical Indicators

 Use OI analysis with indicators like RSI, MACD, or Moving Averages for high-probability trades.

 

Worst OI Mistakes

• Overestimating the OI indicator alone, ignoring price and volume.

• OI data during an expiry week has a tendency to be volatile.

• Changes in OI in context are evidence of losing deals, covered positions, or newly initiated shorts.

 

Failing to see rollover data.

 The best open interest strategies in trading options consider OI only as an additional influence.

 

Benefits of Open Interest

• Confirms the prevailing market trend and how strong it is.

• Early identification of potential reversals.

• Highlights the liquidity levels and relevant/important strike price zones.

• Reduction of guesswork.

 

Open Interest Drawbacks

• OI doesn’t indicate if the positions are long or short or if the total open contracts are in balance.

• Unpredicted events/news and shifts in government policies will render OI analysis pointless.

• It should be combined with price and volume.

 

Conclusion

 To recap, options open interest can be a strong indicator of the trader’s mindset and the market’s inner workings. Understanding how open interest works and integrating it with price and volume will allow a trader to create a more confident and methodical options trading strategy. 

 Even though open interest analysis can be useful for anyone with a trading strategy, and even for positional investors, its mastery can be a powerful tool for market timing and precision entry.

 

DISCLAIMER: This blog is NOT any buy or sell recommendation. No investment or trading advice is given. The content is purely for educational and information purposes only. Always consult your eligible financial advisor for investment-related decisions.