Understanding How To Use Open Interest Data to Your Advantage: To be able to forecast the probable direction of the market is a dream of every trader and more specifically Day traders.
The main objective of any day trader is to capture a fraction of the move for the day. And this can sometimes get challenging because of the sheer uncertainty of the market.
But there is one piece of public information that everyone can access for FREE and that can significantly help you in minimizing trades that are against the existing momentum or trend in the market. And we are talking about How To Use Open Interest Data to Your Advantage?
What Is Open Interest?
Open Interest is the total number of outstanding contracts at any given point in time. It signifies the interest of buyers and sellers at various price levels.
These outstanding contracts keep on changing with movement in the price of the Stocks or Index. Following is the Option Change for the Nifty50 index and we will use this to further understand the Option chain and interpret the Open Interest (OI) Data.
In the table above, OI is shown in the extreme last columns of both the Call and Put Sides. The columns adjacent to the OI column show the Change in OI.
The OI column shows the total Outstanding contract for that particular strike price for both Call and Put Options. And the Change in OI shows the change in the Total outstanding contract for that particular strike price for the day.
So, if the Open Interest (OI) for any particular strike price goes up for a particular strike price, then it can safely be assumed that Sellers are having more interest for that strike price.
In the table above, the OI for a strike price of 18200 on the Put side has gone up by nearly 58000 lots for the day so it can be said that Sellers are more interested in Writing/selling the Put option.
And similarly, for the 18600 Call Option, the Open Interest has been reduced by 1674 lots, so we can interpret selling interest for that strike price as reduced.
You Can Also Check Out Our Course On How To Use Open Interest For Options Trading?
Why Sellers Are Given Higher Weightage While Analyzing The Option Chain?
The sellers are given higher weightage while analyzing Option Chain for the simple fact that the amount of margin required to Write/sell the Call or Put option is much more as compared to the amount of margin required to buy the Call or Put Option. And that simply implies that Sellers have higher conviction as compared to buyers of Options.
How To Interpret Open Interest?
If the number of open interest lots for the particular strike is Increasing (say Put Option) then we can say that there are more sellers Writing Put Options.
And we know that if Put Option is being Sold, then there is a view that the market won’t fall, and that particular strike price zone could act as support in the market.
As we can see in the table above we see OI and the total OI increasing from Strike price 18100 through to 18200 (Put Side) and it can be safely assumed that the price range from 18100 to 18200 would act as support for the market.
The same logic applies to Call Option also. If the number of Outstanding contracts is increasing for a certain strike price, then it can be assumed that those strike price levels would act as Resistance for the market.
What Happens When Support And Resistance Levels Are Broken?
It may so happen that the support and resistance levels shown in the market get broken and the Open Interest data did not hold the levels.
So, in this case, we could see a huge sell-off if the levels of Support get broken or we could see short covering if the levels of resistance break in the market.
This happens because the sellers (of Option Contracts) at those levels book their losses and hence the moves at the break of those levels can sometimes be quick and erratic.
From the discussion above, it can be assumed that Open Interest plays a very important role in understanding the levels of support and resistance in the market.
And we also understood why the perspective of sellers is given higher weightage while analyzing Open Interest Data. And finally, we ended the discussion by understanding the likely move in the market when the levels of support and Resistance are broken.
So, That’s all for the article on How To Use Open Interest Data to Your Advantage?, We hope you enjoyed reading it. Happy Trading!
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