How to use open interest for intraday trading: A key to a successful intraday trade is entering and exiting your positions at the right prices. For this reason, it is vital for a trader to be able to interpret the trends and consensus in the market.
There are various methods one can use to enter a trade at the right time in the market. One of the methods, traders use to enter and exit security is by using open interest.
In this article, we will help you understand how to use open interest for intraday trading.
What is Open Interest?
Trading in futures and options requires the buyers and the sellers to enter into a formal contract. Open interests are nothing but the total number of open contracts that are currently open/active in the market
How To Use Open Interest For Intraday Trading
There are two ways in which you can use open interest for the purpose of intraday trading. The first way is by using the change in open interest in options, and the second way is by looking at the open interests for particular strike prices in the options chain. Let us understand how to use open interest for intraday trading using each of these methods.
Using Change In Open Interest For Intraday Trading
Change in Open Interest refers to an increase or decrease in the number of Options contracts outstanding for that particular strike price. If the OI is going up, then we can assume that there is higher interest for that particular strike price (Call/Put).
An increase in the change in OI means an increase in the number of new contracts opened during the day. A decrease in the change in OI means the number of open contracts that are being closed is more than the number of new contracts being opened.
Using the price and the change in open interest of an underlying security, it is possible to interpret whether the underlying security is going to be bullish or bearish in nature. These interpretations are categorized into 4 concepts that will be explained below:
Using Open Interest Of Specific Strike Prices For Intraday Trading
Unlike equities which have a fixed number of outstanding shares, there is no maximum limit on the number of new contracts that can be created or liquidated.
With the help of these open interests, traders can analyze where the important support and resistance levels are. As options writers invest more money (higher margin required to write/sell) in the trades, their conviction is given more weightage in the market.
Thus, in the option chain, if the option writers are gathered at entered near one specific strike price, that level is considered as the support or resistance level.
In a call option, the strike prices which have a high number of option writers above the spot price are considered resistance levels, and the strike prices with a high number of writers below the spot prices are considered important support levels.
In a put option, the strike prices which have a high number of option writers above the spot price are considered to be support levels and the strike prices with a high number of writers below the spot prices are considered important resistance levels.
The above image shows depict the option chain of Nifty50 as of 21/12/2022. This option chain has a weekly expiry on 22/12/2022.
All the highlighted levels on the Put sideshow support levels in the market and all the highlighted levels on the Call sideshow are levels of Resistance in the market.
In the Option chain, we can see Nifty has good support at level 18,400 and it has its first resistance at 18,450, second resistance at 18,500, and third resistance at 18,600. We derive this data just by looking at the Open Interest around these levels on the Call Side.
In the Put option chain, we can see Nifty has good support at level 18,4500 and it has its first resistance at 18,000 and second resistance at 18,300. We derive this data just by looking at the Open Interest around these levels in the Put Side
By combining the two data, we can see that Nifty is More than likely to move in the broader range of 18300 and 18600.
If Nifty breaks below the levels of 18,400, it will then have its second support at 18,300.
And, If Nifty breaks above the level of 18,450, it will have its next resistance at 18,500 and the third resistance at 18,600.
Traders can use the important support and resistance levels to enter and exit their intraday trades.
In this article, we discussed the basic terminologies required for this topic and we also discussed how to use open interest for intraday trading under which we covered long buildup, long unwinding, short buildup, and short covering.
Though open interest serves as an important source of information to identify the sentiments in the markets and also helps you identify the important support and resistance levels.
One should not take any trading decisions solely based on open interest. It is advised for individuals to make their own trading decisions and confirm their bias using open interest in order for them to get the optimum trade setup.
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