Open Interest defines the total number of open or outstanding contracts presently held by the market participant at a given time.
Suppose, there are five market participant A, B, C, D and E.
Now on 4th Aug, A buys 20 Bank Nifty contracts from B so the open interest would be 20. On 5th Aug C Buys 30 Bank Nifty contracts from D. So the Open Interest(OI) become 50. But on 6th Aug A sells its 20 contracts to D. So the OI will come down to 50. Because these contracts are the old contracts exchanging hands. On the 7th Aug E buys 30 contracts from C. Now here also the Open Interest will remain same. the reason is this contracts was the old contracts.
The point we need to remember here is that Open Interest will increase only when the fresh contract is exchanging hands. There is no impact of old contracts in open Interest.
So far we have understood the how Open Interest functions.
Please take a look at the image. The image portrays the basic interpretation of market using Price and Open Interest.
How Open Interest helps to identify Support and Resistance
We know time plays one of the key factor in options trading. Due to this reason we experience more sellers’ presence in the market than buyers.
Call options seller stands in the Bearish side and a Put options seller holds a bullish view of the market. So if at any particular strike price, a huge Open Interest build up is visible then it is obvious that it definitely signifies something important.
This huge addition in Open Interest for any certain strike price define possible support and resistance level. For call option if at any certain level huge OI is present it depicts as a possible resistance level and for put option addition in Open Interest signifies possible support level at that strike price.
As we know the OI is only applicable for future and Options contracts. We can identify potential support and resistance level by taking the help of Open interest from the option chain.
Suppose in a security price’s call option OI has been built up on a certain level,And the same is for put option. So we can assume that two zone could be the possible Resistance and Support zone for the security.
Let’s understand whole scenario with a real-time example.
We have taken Nifty option chain of July month. As we can see in this picture in the call option (CE) segment there is a huge addition of OI in the 11200 Strike price in other hand for put options (PE) there is also significant addition of OI in 11000 and 10900 strike price.
So we can easily decipher that Nifty having a resistance at a level of 11200and for Support we can take 11000 and 10900 levels.
Now let’s break it more.
What will happen when the price goes above 11200 level?
Option seller will close their position once the price goes above 11200 level because they will be facing loss above that level. This short covering will push the price much higher.
In case of 11000 and 10900 levels.
When the price goes below 11000 or 10900, the put seller will start closing their position because they will be incurring loss. So we may experience a correction up to 10600 level.
Let’s check it one the chart.
This is the daily chart of Bank Nifty. We have drawn Resistance line at 11200 level and the support line has been drawn on 11000 level as well as on 10900 level. It does not need any deep understanding of technical analysis to understand these levels are going to be the next Support or Resistance level for the Bank Nifty. We can see there are multiple attempt has been made by the index when it tried to break these levels.
Trading using Open Interest:
Open Interest helps a trader to understand potential support and resistance level for a stock as well as for any index. Some traders also take trades based on Open Interest.
Anyone can check open Interest for any underlying in the equity derivatives tab from nseindia.com. Also you can check StockEdge application. StockEdge not only helps you to understand Open Interest for any security it also helps you find out High Increase in Open Interest, High Decrease in Open Interest, Index Strikes with High Increase in Call Open Interest, Index strike with High decrease in Put Open Interest etc. There are multiple scans available like this in the StockEdge application and there is also other exciting feature available related to the Stock market. Please take a trip and see how amazing the application is.
Below Image showcasing Open interest section of Stock Edge.
Open Interest is a value which derives number of fresh contract exchanging hand or building up. Based on the number traders take trading decisions. Please remember Open Interest act as support while you are taking any trading decision. Trading only based on Open Interest can come out very risky so please consider other technical and Fundamental factors to mitigate your risk.