Thread by @kaushikaki

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Open Interest and how to effectively use open interest for our analysis
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Let us start with understanding what is Open Interest and why traders are obsessed with OI data. What information we can fetch from the data and why analysing it is important?
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Open interest refers to the total outstanding (or open) contracts in a derivative market at any given time. The quantitative value shows the total number of contracts in the market that have yet to be liquidated.
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Open Interest (OI) is a number that tells you how many futures (or Options) contracts are currently outstanding (open) in the market.
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Remember that there are always 2 sides to a trade – buyer and a seller. Let us say, seller sells 1 contract to the buyer. The buyer is said to be long on the contract and the seller is said to be short on the same contract. The open interest, in this case, is said to be 1.

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I am not going into detail about how OI is generated. We will stick to the analysis of OI data for this thread. But just to give you a quick sense of OI generation.

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OI Generation

OI increase: When a new buyer and seller enter into a contract
OI decrease: When contracts are closed or exercised
OI Unchanged: When an old seller and a new buyer enter into a contract

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Open interest or OI interpretation:
OI should never be looked at in isolation but it should be looked at about the movements in the stock price and also the volumes. There are 4 cases to look at in OI

Image attached
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How OI is different from Volume:
1. Open interest information tells us how many contracts are open and live in the market. Volume on the other hand tells us how many trades were executed on a given day.

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2. For every 1 buy and 1 sell, the volume adds up to 1 whereas OI depends on new market participation
3. Clearly volumes and open interest are two different; buy seemingly similar sets of information.

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4. The volume counter starts from zero at the start of the day and increments as new trades occur. Hence the volume data always increases on an intra-day basis. However, OI is not discrete like volumes, OI stacks up or reduces based on the entry and exit of traders.

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Interpretation of Volume with Price
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IMP note:

Trading volume in F&O is compared to OI to understand whether the volumes are resulting in the actual creation of fresh OI or not. If volumes are high but OI is not building, it means there is speculative activity with an inadequate focus on building OI position.
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Shifting OI is an interesting concept if you are a positional trader. OI by itself may not be too indicative or suggestive. However, shifts in OI typically happen over time and hence such medium to long-term trends are more suggestive.
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How to interpret the shifts in open interest or OI. Here is what you need to know about shifts in open interest.
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OI shifts give interesting clues for traders and investors to take positions in equities. At least, it acts as a ratifying factor if not as a deciding factor.
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OI acts as a lead indicator of long or short interest building up in stock. This is normally quite evident when you combine the same with volumes and price moves.
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Expanding OI indicates a widening of the contract exposure and is a safety signal. It gives a degree of comfort that a speculative bubble is not here to bite into your profits.
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OI gives a clear indication of stocks bottoming out or stock prices topping out. That is because any major turnaround in the stock, either on the positive side or the negative side is preceded by open interest or OI shifts.
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OI analysis is an essential aspect while trading in the futures and options market. It indicates the direction of money flow in the market. Following it along with volume and price data can assure a high probability of success and profitability.
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OI aids in the identification of liquid choices available based on the number of outstanding contracts daily. The OI is quite important in determining how liquid a market is. The more OI there is, the more liquid the market is.
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Remember, these are just indicative interpretations and you have to work this interpretation by considering more variables like price action, market flow, and broader market conditions. What matters is that OI is an important data point for F&O traders and equity investors.
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That's a wrap from OI Analysis!

In the coming weeks, I will be writing on Option OI analysis for trading.

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