In the world of options trading, the investor is given constant information about what is happening in the options market. Two of those pieces of information are Options Volume and Open Interest.
Options Volume represents all of the transactions made during a trading session updated in real-time.
Open Interest represents the number of open contracts at the start of each trading session and is updated once per day prior to the market opening.
How Is Option Volume Calculated?
Option Volume is different from stock volume in some fundamental ways. When you’re investing in stocks, volume represents shares trading hands. Typically trading volumes in stocks are far smaller in scale than the total shares available in a stock.
Options volume, on the other hand, can very often exceed the total contracts outstanding represented by Open Interest.
Options Volume is calculated in real-time after every transaction. This information is typically reported within the options chain and will be updated as frequently as your particular brokerage and account provides.
Every transaction is counted.
If you buy to open 10 calls, volume increases by 10 during the trading session.
If you then sell these calls to a second investor, volume increases by 10.
If this second investor closes these 10 calls, volume increases by 10.
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How Is Open Interest Calculated?
Open Interest is calculated the same way for options trading as it is for futures trading. This information is also reported within the options chain, however it is updated once daily prior to the market opening and will not change over the course of a trading session.
Open interest represents all contracts that remain open and nets out trades from the previous session that offset.
Therefore using the same trades from above:
If you buy to open 10 calls, open interest does not change during the trading session.
If you then sell these calls to a second investor, open interest does not change.
If this second investor then closes these 10 calls, open interest does not change.
However, at the end of the session the Options Clearing Corporation (OCC) nets out any offsetting trades and reports simply the remaining open contracts.
In this example, since the options were opened and closed on the same day, and despite having changed hands, the net effect on Open Interest is zero.
What Do Option Volume and Open Interest Indicate About Options?
As far as assessing what these two data points indicate, it depends on whether you consider yourself a “fundamental” trader or a “technical” trader.
• Traders who use fundamental analysis believe in analyzing company and market data to determine what is happening in the markets. They look at corporate metrics such as profits, operating margins, debt ratios, etc, as well as some limited market data.
• Technical traders primarily focus on market data and use it to predict market sentiment and price movements.
Fundamental traders look at the Open Interest as an indicator of liquidity in the market. And if you dig into the typical options chain, you’ll see that higher Open Interest corresponds to lower bid-ask spreads.
These two factors taken together, result in more rapid order filling and increase the likelihood of better, i.e., more competitive, pricing.
The fundamental trader looks at Options Volume as a first indication of cash flows in and out of the option. However, these cash flows won’t be confirmed until the end of the day when a comparison between Open Interest changes from the previous day will confirm this analysis.
Increasing Open Interest shows cash moving into that option.
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Technical traders also look at Open Interest and Options Volume as indicators of liquidity and cash flows, but their analysis doesn’t stop there.
Technical traders look at these increased cash flows and liquidity improvements and believe that the strength in the Options Volume and Open Interest indicate confirmation of the trends occurring in the price of the underlying asset.
For example, if the underlying asset is seeing price increases and call volumes and Open Interest are also increasing, then the technical trader sees confirmation of the trend and these factors reinforce the likelihood of the trend continuing.
Conversely, if the Options Volume and Open Interest are changing at a slower pace, this may indicate that the previously existing trends in the underlying market – whether up or down – may be coming to an end.
Technical Analysis, Other
Although the following phenomenon falls under technical trading, it should really be its own brand of trading.
Often, you’ll hear experienced options traders talking about spikes in Option Volume and Open Interest as an indication of what the “smart money” is doing, or that “somebody knows something” about a particular company or a particular trade.
Consider this a red flag. First, just because an investor has made a large investment, doesn’t make them “smart.”
Second, why have they made that investment? Is it a single position, or one of a few different types of investments, or a combination trade that you may not know about, and with different investment goals than what you are pursuing.
Finally, the people who made the trades, and those who identify these spikes, typically have access to information and resources the typical investor does not have access to. That means while they might be going into a trade with eyes open, you may not have the same visibility.
|Option Volume||Open Interest|
|Total of all transactions during a trading session||Total of all open contracts at the start of a trading session|
|Updated continuously after every transaction||Updated once per day prior to the trading session|
|Opening a transaction increases the volume||Opening a transaction will increase Open Interest|
|Closing a transaction increases the volume||Closing a transaction will decrease Open Interest|
|Indication of liquidity||Indication of liquidity|
|Indication of Cash Flows||Confirmation of Cash Flows|
Options Volume and Open Interest can be useful data points for the options investor.
Depending on your particular investing approach, fundamental versus technical, you may use this information in varying ways to inform your investing decisions.
If you’re ready to try your hand at options trading, You can set up an Active Invest account and trade trade options online from the SoFi mobile app or through the web platform.
And if you have any questions, SoFi offers educational resources about options to learn more. SoFi doesn’t charge commission, and members have access to complimentary financial advice from a professional.
Photo credit: iStock/BartekSzewczyk
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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.