In terms of option trading, open interest means the total number of option contracts that are currently active, and have yet to be closed out, exercised, or expired.
Open interest is an important concept to understand as it can be used to gauge the market activity and liquidity of an option. This article will explain everything there is to know about open interest and how it can be a useful tool for option traders.
When an investor buys or sells an option contract, he must indicate whether the transaction is an opening or closing transaction.
Open interest will increase when buyers and sellers open new option contracts, or when new option contracts are created. Open interest will decrease when buyers and sellers close out their option contracts, which could be done by taking offsetting positions or by exercising their options.
For example, assume an investor buys 15 put options for ABC indicating he wants to open his position. The open interest for that put option would increase by 15. If the investor wanted to sell those same options and close his position, then the open interest would decrease by 15.
In another example, assume a buyer buys 10 put options for ABC to open. Then, the buyer is matched with a seller selling those same 10 put options to close. The total open interest for this transaction would not change; it would not increase nor decrease.
As mentioned earlier, open interest is a measure of market activity and liquidity. Little or no open interest means that the option contract has no opening positions, or that all positions have been closed. Whereas high open interest means that there are many contracts still available to be opened and that more people will be active in that particular option.
A high open interest means that the liquidity for that option will be high. The more liquid the contract is, the more reasonable the price spread for that option will be. Since there are more buyers and sellers, there is a higher chance of someone wanting to pay for the option the same price that someone would want to sell the option.
One more thing to note, the value for open interest on a particular option can be found on that underlying security’s option chain.
After having read this article, one should understand what open interest is and how it can be used to gauge an option’s activity. This is an important concept to remember when looking at option contracts.