Option trading ideas using open interest

The greater the amount of trading during a market session, the higher the trading volume. Check out an introduction to the concept of open interest in Intro To Open Interest In The Futures Market. The greater the volume, the more we can expect the existing trend to continue rather than reverse. Lastly, if the total open interest is falling off and prices are declining, the price decline is likely being caused by disgruntled long position holders being forced to liquidate their positions. Technicians believe that volume precedes price, which means that the loss of money of either upside price pressure in an uptrend or downside pressure in a downtrend will show up in the volume figures before presenting itself as a reversal in trend on the bar chart. The rules that have been set in stone for both volume and open interest are combined because of their similarity; however, having said that, there are always exceptions to the rule. Now, if the price action is rising and the open interest is on the decline, short sellers covering their positions are causing the rally. If you are a new technician starting to understand the basic parameters of this study, look at many different charts of gold, silver and other commodities so you can begin to recognize the patterns that develop. There is no need to study a chart for this indicator since the rules are the most important area to study and remember. Money is therefore leaving the marketplace; this is a bearish sign.

Open interest is an indicator often used by traders to confirm trends and trend reversals for both the futures and options markets. When open interest is high at a market top and the price falls off dramatically, this scenario should be considered bearish. If prices are in a downtrend and open interest is on the rise, chartists know that new money is coming into the market, showing aggressive new short selling. This scenario will prove out a continuation of a downtrend and a bearish condition. Open interest represents the total number of open contracts on a security. The chart below summarize the rules for volume and open interest.

In other terms, this means that all of the long position holders that bought near the top of the market are now in a loss of money position, and their panic to sell keeps the price action under pressure. Technicians view this scenario as a strong position technically because the downtrend will end once all the sellers have sold their positions. If price is nearing the top or the bottom part of the range, and Open Interest is starting to decrease, it suggests that price may bounce off the wall of the range and reverse as this shows that traders are closing out of their current positions. An increase in Open Interest means that there is an increase in contracts for that particular stock or ETF, which means that there is more money flowing into the market. An increase in implied Volatility means that the market is stating that there is an increased chance that price will move further from its current location. If Open Interest is increasing and Implied Volatility is increasing, it implies that the current trend will continue.

If Open Interest is decreasing and Implied Volatility is decreasing, it implies that the current trend may halt or reverse. So that is using Option Open Interest and Implied Volatility as sentiment indicators. An increase in Open Interest means that there is still an increase in contracts for that particular stock or ETF, which means that there is more money flowing into the market. In this video, we will look at using Option Open Interest along with Implied Volatility to measure market sentiment. If Open Interest is increasing and Implied Volatility is decreasing, it implies that the current trend may level off. As price moves toward the edge of the range, if Open Interest is increasing and Implied Volatility is increasing, it implies that price may break out of the range. If you remember from my overview video, Option Open Interest is the number of outstanding option contracts or positions in the market.

ETF is in an up or down trend. An increase in Open Interest means that there is an increase in contracts for that particular stock or ETF, which means that there is more money flowing into that market. If Implied Volatility is also decreasing, this helps confirm the possibility that price will bounce off the walls of the range and reverse. ETF is in a range. However, the decrease in implied Volatility means that the market is stating that there the chance of price moving further is decreasing. Option Open Interest is one of the key sentiment indicators that traders look at to help gauge the next step for price.

The decrease in Open Interest means that the number of outstanding contracts is going down from traders closing out of their positions, and the decrease in implied Volatility means that the market is stating that the chance of price moving further is decreasing. If one looks at the options chain to gauge, the person will see a huge sale of call options and a relatively lower sale of put options. That is open interest of calls begin to fall as price rises. If OI remains flat after substantial price rise OI it indicates that market is forming a top. But post poor results, if company gives positive guidance for quarters ahead, the stock could surge despite posting poor results and cause a loss of money to the put buyer as call writers start covering their shorts. Similarly, rising OI but falling price indicates bearish trend. An outstanding buy or sell position on a stock or index futures or options contract. So, the buyer will probably be on the wrong side.

If a company is expected to perform poorly prior to results the stock will fall and open interest rises. When OI does not rise much after a sharp fall in prices it indicates formation of a bottom and trend reversal. Rising OI accompanied by rising price is indicative of bullish trend. ET provides the lowdown. What more can happen? Sometimes the buyer might see many calls being written and so, interpret that as meaning stock will face downside pressure and buy a put. Stock market initiates with an interest in derivatives will often come across the term open interest. But actually the seller had sold or written more calls knowing downside chances are greater or any possible upside will be capped. Why can it mislead, especially during result season?

How important is open interest? High volumes along with high OI indicates greater hedger and trader participation on a stock futures or options counter. When writers feel a stock will rise, they sell puts and partly finance their own purchase of calls with premia received from buyers. Therefore, it is important to take an informed decision and trade with strict stop losses in place. Higher the OI, deeper the market. This is a very useful tool in understanding, along with price data, whether a market has topped or bottomed, among other things. But often it could mislead those wet behind the ears. Conversely, high volumes and low OI means more speculative interest in a counter. Higher call OI than put OI will probably make the person inclined to buy a call, thinking that the stock will rise post result.

In a bear market, volume has a tendency to increase on declines and decrease on rallies. That is due to the exchanges and their reporting requirements. Volume measures the number of contracts that exchanged hands during the trading session. VOI does not have straight and simple trading rules. Trading volume usually increases dramatically at tops and bottoms in the price chart. If prices are up and volume and open interest are rising, the market is strong.

Traditionally, traders have used the rules listed below for volume analysis. If prices are down and volume and open interest are rising, the market is weak. If prices are up and volume and open interest are declining, the market is weak. In short, fewer buyers are willing to enter the market at current price levels. Actually, they imply very similar market conditions. FutureSource tracks volume and open interest on an individual delivery month and total symbol basis. VOI is a measurement of the ebb and flow of the underlying market. Volume and open interest information is often a quite useful indicator, especially when the trading volume and open interest deviate from expected patterns. At first, it appears these trading rules are in conflict.

Are traders liquidating their positions? Does VOI confirm the trend or suggest a change in trend? For instance, if the market makes new highs while volume falls short of the previous high, it implies the market is getting weaker. The values for the volume and open interest are transmitted from the exchanges. It measures market activity. For example, the study on a daily November Soybean chart only displays the volume and open interest figures for the November contract. Volume and Open Interest can be a barometer of future activity and direction.

If prices are down and volume and open interest are declining, the market is strong. You can use volume and open interest to determine market action. This study has no computations. It gauges market participation. In a bull market, volume has a tendency to increase on rallies and to decrease on reactions. The VOI data creates a lot of questions but not many simple answers to those questions. However, the actual volume and open interest figures are always one day behind price information. Open Interest is the total number of outstanding contracts. You must watch for divergence between price direction and volume.

Options to predict stock price movements. There is a concept in the markets called option pain. Open interest is the total number of contracts that are currently in existence and have not been offset by closing trades. Understanding open interest can seem confusing at first, but our instructors at Online Trading Academy do an incredible job at making difficult concepts not difficult to understand in the classroom. So, what can a retail trader do about this pinning? How many of you know people who are losing money trading options? There is a term for this action, pinning. If we know this, then all we have to do is find the area where most traders are making mistakes and then take the opposite position. Remember that the novice traders are the ones who usually buy options.

The problem is in catching the culprit and the SEC punishing them. Open interest shows us where traders are putting their money. If you were to buy an option to open a position and the person who sold you the option is also opening a new position, volume would increase by one and open interest would increase by one. Open interest is important to stock traders and investors as well as option traders. Since both of you are closing positions, the option contract is not needed anymore and open interest goes down even though the transaction increases the volume reported. While I was in class on November 20th, options expiration for the November 2015 monthly options, I checked the open interest on the expiring options contracts for SPY and QQQ.

To learn how to identify the zones accurately and efficiently, visit your local Online Trading Academy office today. Pinning is illegal in most exchanges in the world and traders who participate in this high volume trading in an effort to manipulate prices could face penalties. This is different than volume which is the number of contracts traded for the day. The open interest information provided here is only a decision support tool. In an effort to profit from large option or futures positions, institutional traders will often buy or sell the underlying stock in an effort to push prices to a point where the close will benefit them. Trading this can be very risky as you need to be quick in your decision to enter and exit when the momentum is slowing, not reversing. Trades should only be entered based on supply and demand zones.

How many people do you know who are making money trading options? We can use the knowledge that sellers tend to make money to predict potential price movement for stocks just before the expiration of the stock options. That is where the largest open interest happened to be. Typically, every hand is raised to this question. Where there is a large amount of open interest, there is also a large probability that the price will not close there by expiration. This is because if it does, then the sellers of those options would stand to lose a lot of money. These traders attempt to pin the price of the stock or ETF to profit from a derivative position.

Recognize that it does happen and either stay out of the market or trade the momentum. When a seller of an option sees the price of the stock move to where they would lose money, they are feeling pain. Open interest is a statistic unique to options and futures trading. Since prices opened above this range in the morning, traders should have been looking for opportunities to short the ETF until it settled into the range suggested by the open interest. It is safe to say that most novice traders in the world are not trading options properly. We will then have a high probability for success in our trades. This means that the price will often close on options expiration day just above or below the price where the greatest open interest lies and the least amount of pain would be felt. By looking at where the open interest of a stock or ETF is, we can make assumptions on the price levels where there would be a lot of pain.

It is not for everyone, but if you are prepared you may be able to profit from this pinning that occurs in the markets every expiration day. Open interest would have decreased if you had sold your option to someone who had already sold an option and was buying to close their position. But does it really work? If you then sold your option to someone else who did not have a position, then volume would increase but the open interest would not change as you transferred your interest to someone else. One note of warning is necessary. Obviously, the results here beg the question of whether what we have learned from the futures markets can be applied to equities. This has become even truer with the advent of electronic markets. It means we will add or subtract a value each day to an ongoing line or indicator. Conversely, when price makes a new rally high that is not matched by a new high in OBV, the indicator is suggesting that the market has perhaps topped.

In practice, it is useful to confirm a trade or to focus attention on a potential trade. Futures traders have different problems with volume in that the largest players, commercial firms that have a business reason for trading the derivative, are usually hedging positions. The next step in the formula is to then add this value, a combination of price change and open interest into the original OBV formula. Ray view of OBV was showing a different picture. We then add the OBV value to this cumulative sum. Not only that, it also means we are incorporating price and trend change into the formula. The Williams POIV AD is a specific formula that compensates for the close within the range relationship, as well telling us how much OI to use, but it is an indicator, not a trading system. In the futures markets, volume is not what it once was.

OBV was holding up, not going to a new low, suggesting that on the September sell off, the stock was in strong hands. We saw massive divergence between price and the actual buying and selling as evidenced by the cumulative flow of volume, as measured by the OBV indicator. Volume is a powerful indication of market strength. The general philosophy behind OBV analysis is to find a stock that is making a new low in price while the OBV line is not matching that low. An even greater problem crept in with the advent of arbitrage programs, whose trades do not necessarily represent supply and demand but minute price differences that are being bought and sold in huge chunks to lock in gains. Despite the problem, volume indictors have proven their worth, but while it is a good idea to watch the cumulative flow of buying and selling pressure, you should not assign all of this buying and selling to bulls and bears. Problems for stock traders arise when a huge block of stock is swapped from fund to fund; this is not real buying and selling pressure.

This is a continual flowing line of accumulation and distribution within the market. OBV to get an idea of how it works. Open interest is the number of outstanding contracts in a particular market. As price spurted up in late January, breaking out and sucking technicians into the stock, there was no support from volume buyers. Traders really have a problem these days. The first measure is perhaps the most important, CumulativeSum. This was the start of the fall, which continued into March and April and gave away to a significant tumble in the fortunes of Microsoft longs. Although we can see here that volume is a useful measure for the markets, there are real problems when we use volume.

While POIV presents a very different view of accumulation and distribution it is used in the same fashion. It is not intended to stand as the sole reason to initiate a position in the market. Hopefully, this index will add a new depth to understanding the daily pattern of buying and selling that goes on in the marketplace. Instead we arrived at a percentage of the range, which is then our multiplier for open interest. What the Williams POIV AD does is combine all of these into one measure of accumulation and distribution so that we can more clearly see the inflows of money into the marketplace. The lesson here is that the indicator works on not only natural resource commodities, but also the financials. In the old OBV technique, both days would have assigned the total volume for the day. These examples indicate that open interest is indeed a better overall measure, at least for commodities.

The constants are price change, close within the daily range and total open interest. However, in many cases, we can get a better idea of its significance by tracking it over time, in terms of moves in the markets. This condition suggests that sellers have dried up and the stock is in strong hands. There are two sessions of volume: pit and the electronic session. Joe Granville, who contends he discovered the idea on his own in 1961, it perhaps may have originated with two guys in San Francisco, known only as Woods and Vignolia. So, they are not taking on speculative positions that represent buying and selling pressures. Combined with other concepts, such as keying off the open, we can focus on something more germane to trading based just on volume, or what some might consider related volatility indicators, such as daily ranges. Futures traders can consider at least one solution to this problem: open interest. These can be two different things entirely.

Notice the bullish divergent pattern in September 2005. This is not an oscillator. The formula is calculating the cumulative sum of open interest times the net change in price, divided by the true range. However, we are still unwilling to use all of the open interest on that day.