Not many traders check this little number in their lists of potential trades… but they sure ought to.
It's so powerful and useful it can tell you how complex trends are forming – or falling apart. And it can get you on the right side of those trends, too, helping you get into (and out of) trades at the exact right time.
This number can even help you navigate your open positions. And since it's so often overlooked, you'll have a definite leg up on other, less well-informed traders out there.
News outlets like Yahoo! Finance and Google publish it every day, next to every available trade, for free.
There's not much to interpret, either. You'll be able to tell what you need to know right away… once you know what to look for.
Let me show you…
Checking Open Interest Should Be Part of Your Daily Routine
Believe it or not, some traders never look at open interest (OI), but it's one of the first things I do in the morning.
OI is simply the total number of options contracts – long and short – for a particular strike price that are "open."
Now this is not to be confused with "volume." Although the two can – and should – be used in tandem, OI and volume are completely different. We'll talk about volume in a moment.
OI is exactly what it sounds like – the interest in an options position. OI increases or decreases depending on the number of traders entering and exiting trades. But remember that for every options contract, a buyer and a seller are required. OI can track the increase or decrease in the number of contracts that particular day, either as a positive or negative number.
OI can be high, low, or nonexistent.
When OI is high, an option is said to be "liquid," and it means there's a large number of buyers and sellers active in the market. When OI is low, we can say an option is "illiquid," and that means there's a small number of buyers and sellers active in the market. And when OI is nonexistent, as can be the case, it means there's no active market for that particular options trade. You better believe that's illiquid.
And so, the higher the OI, the quicker – and cheaper – it is for you to get in and out of your trades.
Let's take a look at a chart showing high OI in the options market. What you're about to see is generally freely available every day from financial news sources, in this case, the Yahoo! Finance Options Center.
You can see in the chart above that the Bank of America Corp. (NYSE: BAC) options, in this case BAC Jan. 17, 2017 $17 calls (BAC170120C00017000), for example, are at the top of list when it comes to high OI. There are lots of traders interested in and trading these calls.
What's more, you can see in the "Change" column that the OI for this options trade increased by 0.3% since the OI was last reported.
That's significant. It could indicate that a trend is changing – whether forming or reversing: An increase in OI with an increase in price could indicate an upward trend, while a decrease in OI with a decrease in price could indicate a possible reversal.
Now there's really no way of knowing exactly who's on what side of a trade simply by looking at OI. It's also difficult to determine the exact cause for a large bump or drop in OI on a trade. But the truth is, OI is one of the best tools you can use to determine the liquidity of your trades.
For most investors' purposes, liquidity is the ease with which a market can be traded.
More open contracts means higher liquidity, while fewer open contracts means lower liquidity. Higher liquidity makes it easier for you get your orders filled and quicker for you to exit your trades. Lower liquidity makes it harder for you to get your orders filled and slows down your trade exit, too.
Be Careful: Open Interest Is Not Volume
You can use OI to determine liquidity, which is essential when it comes to moving on your trades quickly. You can also use OI in tandem with volume to determine liquidity. Unlike OI, which is the number of contracts in the market, volume is the number contracts (or, for stock positions, shares) traded in the market for the day (or other specific period of time). An increase or decrease in volume could also indicate forming or reversing trends in the market.
Most places that track open interest also track volume, like the Yahoo! Finance Options Center:
By checking volume, you can also determine the liquidity of the market and use that information to pull the trigger on your trades – or trades you might be interested in. As a rule of thumb, it's better to use markets that trade at least 300,000 shares a day, although 1 million shares a day is even better.
How to Easily Interpret Open Interest and Volume
As we discussed earlier, OI – and volume – can give you a sense of a forming or reversing trend.
Here's an extremely simple chart you can even print and keep at your computer to determine a possible trend or reversal using OI, volume, and price:
|Rising||Rising||Rising||Market is strong|
|Rising||Falling||Falling||Market is weakening|
|Falling||Rising||Rising||Market is weak|
|Falling||Falling||Falling||Market is strengthening|
The best part is how widely and freely available all this critical information is. You can check with your broker if you like, or you can save yourself the time and the call by tracking it on your own.
I've used Yahoo! Finance Options Center in my examples here, but plenty of other options trading and general financial sources let you track open interest, volume, and price. The Options Clearing Corporation (OCC) is another favorite source of mine.
Wherever you get this information, it's well worth taking a minute to check for it every day.
About the Author: Tom Gentile is one of the country's foremost experts on options trading. He's the editor of Money Calendar Alert, which uses Tom's proprietary trading tools to identify only those trades which have the potential to double in 30 days or less. His four latest trade recommendations could, if executed properly, bring in 750% in total gains before August 15. The trades launch June 14. Click here to log in to Money Calendar Alert for instructions or click here to learn more.
About the Author
Tom Gentile is widely known as America's #1 Pattern Trader thanks to his nearly 30 years of experience spotting lucrative patterns in options trading. Now, he's diving into the biggest market in the world - one that almost no one has heard of before.