What is open interest, and how does it work? If you’re trying to understand the pulse of the markets on a deeper level (and improve your trading strategy in traditional and crypto markets alike), you have come to the right place.
In this guide, our team of experts will help you explore the concept of open interest. You will learn what it is, how it works, and how it can help you make better investing decisions. Let’s dive in!
Open Interest Definition
Let’s start from the basis: what is open interest, and how to calculate it?
The open interest is the total number of derivative contracts (options, futures, or others) held by market participants at the end of the trading day (in traditional markets) or at a specific time in crypto exchanges, where the market operates 24/7 without any break.
This metric is calculated taking into account all the contracts that have been initiated but are yet to be closed or exercised by the parties involved.
Trading volume and open interest are different metrics, as trading volume just represents the total number of contracts that have been traded during a specific range of time. It resets itself at the end of that time range.
Open interest provides insights and reflects the level of interest or disinterest in particular assets.
This is a common concept in traditional markets, but it also applies to crypto markets, which currently feature derivative instruments for various purposes, like hedging, income generation, and risk management.
Open Interest in Crypto Trading
As already mentioned, a remarkable difference with traditional markets is that crypto markets are always open, so the exchanges keep track of real-time open interest, without the 1-day lag.
That’s why open interest may change rapidly throughout the day, as new positions are opened or existing ones are closed or exercised.
The main exchanges offering these derivative instruments are:
The most popular crypto offering derivatives markets are BTC, ETH, BNB, LINK, and ADA.
Given the high volatility of the underlying assets, open interest turns out to be a crucial metric to master trading decisions and strategies, when complemented with other fundamental technical analysis tools.
During periods of high price volatility or sideways movement in the market, exercise extra caution, as relying solely on open interest may not accurately identify emerging trends.
In these highly dynamic environments, traders will always need to fine-tune their crypto trading strategy.
Open Interest in Options Trading and Futures
What is open interest in options trading and stock index futures?
The basic concept is the same: it represents the number of open contracts, which have not been closed, expired, or exercised.
That’s why a higher open interest, in itself, is associated with better liquidity and implies easier market entry and exit.
On the other hand, a decrease means lower liquidity, as contracts are being closed and there are fewer market participants. In this scenario, reducing liquidity can also lead to larger price fluctuations.
However, due to the different nature of these derivative instruments, there are some differences:
- A futures contract obligates both the buyer and the seller to fulfill the terms at a predetermined time and price, while options provide the buyer with the right (but not obligation) to buy or sell the underlying asset within a specified period, at a set price.
- When an option is exercised, it affects the open interest, but when an option is assigned to another trader, it doesn’t impact the open interest, as the contract remains open.
There is a separate open interest for call options (option to buy) and put options (option to sell), while futures’ open interest represents the total open positions, both long and short.
Calculation and Interpretation of Open Interest
As previously explained, open interest represents the total number of open derivative contracts (options, futures) that are currently open.
The figure reflects the flow of money into a particular market, hinting at the popularity of the related underlying asset, and the subsequent market sentiment.
This metric is not predictive in itself and is more valuable in conjunction with other fundamental indicators, like price, trading volume, and trend strength.
The analysis can also be complemented with additional technical indicators, to get a more detailed view of the market conditions.
Calculating Open Interest
The correct open interest calculation is quite simple and follows these rules:
- It takes into account the total number of derivative contracts that have not been settled, exercised, closed out, or expired.
- The transfer of existing contracts doesn’t affect the overall open interest.
- In traditional markets, the calculation is not adjusted during the day.
- In the crypto markets, the calculation is in real-time, as these markets operate 24/7.
Interpreting Charts
When it comes to interpreting open interest charts, there are several key elements to keep an eye on:
- Rising open interest with rising prices indicates a strong upward trend and acts as a confirmation of the bullish momentum.
- Increasing open interest paired with falling prices signals a strong selling pressure and the likelihood of persistent bearish market sentiment.
- Declining open interest with falling prices indicates a possible reduction of the downward trend and a possible trend reversal.
- Falling open interest with growing prices signifies a potential stop of the bullish trend and a possible trend reversal.
To sum it up, when open interest is high it acts as a confirmation of the current market direction, while when it’s low it can signify a halt of the ongoing trend and a potential inversion of it.
Thus, it can be a tool for navigating bullish and bearish markets.
Open interest and trading volume are distinct metrics, but they need to be used in conjunction for a successful market analysis.
The former measures the longer-term market sentiment (contracts kept open over time), while the latter reflects the number of contracts traded within a given period, offering insight into imminent trading momentum and providing a short-term indication of the market activity.
High open interest and high trading volume suggest a robust and active market.
Open Interest and Technical Indicators
When combined with other technical indicators, open interest provides traders with a holistic view of the market conditions and assists in finding strategic trading points.
The most common indicators for this purpose are:
- Moving Averages (multiple EMA/SMA)
- Momentum Indicators (RSI, MACD, ADX)
- Volatility Indicators (Bollinger Bands, ATR)
- Volume Indicators (OBV, MFI)
In conjunction with such market indicators, open interest can help to determine the timing of market tops and bottoms, providing additional support to current price trends.
However, its utility decreases when the market is not trending, and when it is considered without an accompanying analysis of volume and price action.
Strategies Leveraging Open Interest Analysis
A clear understanding of open interest can be leveraged in various trading strategies. Volume and open interest can work together to determine respectively short-term and long-term market sentiment and future price action.
Open interest confirms ongoing uptrends or downtrends. Divergence between open interest and price signals trend reversals, aiding entry or exit points in trading strategies.
Strategies for Options Traders
Option traders can utilize open interest in a variety of ways:
- Analyzing long-term market sentiment to make informed trading decisions
- Identifying options with significant trading activity, as an indication of the presence of institutional or well-informed traders in the market
- Pinpointing support and resistance levels, looking for possible breakouts or breakdowns
- Checking discrepancies in open interest puts and calls to get bearish or bullish confirmation
Additionally, options trading provides great flexibility, as it can be used for risk management, hedging, and speculation.
A very popular tool for better analyzing this derivative market is the option chain or option matrix. It allows one to visualize and compare the different options contracts available easily.
Indeed, there are many strategies that traders can use to manage their risk and better allocate their investment using options trading, among which:
- Long calls
- Long puts
- Covered calls
- Protective puts
- Long straddles
These strategies aim to use options trading to mitigate the risk related to the investment or trading in the underlying asset, so that traders can better protect their capital, in case the asset is not performing as expected, by covering the loss with the gain given by options.
Strategies for Crypto Traders
Crypto traders can always use open interest, together with price analysis and volume, to get trend confirmations, find support and resistance areas, and understand market sentiment.
Open interest is still a useful tool for implementing risk management strategies and hedging.
However, there are a few differences in how they may use open interest:
- The crypto derivatives market is relatively new, compared to the traditional ones, and open interest data, provided by many different crypto exchanges, may not be easily trackable
- Market sentiment may shift very rapidly and trends may change very fast in this kind of market, impacting the interpretation of open interest data
- The lack of strict rules and institutional supervision can result in increased market manipulation and speculative activities, affecting the open interest data and its reliability
Furthermore, open interest often refers to long-term market sentiment, so it would be wise to use it carefully for short-term strategies, like in day trading.
Tools and Resources for Tracking Open Interest
There are several tools and resources that can assist traders in monitoring open interest data. There are official institutions, like the Options Clearing Corporation in the US, providing options trading and open interest data, and similar ones in other countries.
This data is usually reserved for big companies, while it’s easier to use web trading platforms for ordinary traders. For crypto traders, there are some notable platforms, like CryptoQuant and Coinalyze, freely offering aggregated data from the main exchanges.
Limitations and Challenges
Despite the significant benefits of open interest analysis, we must be aware of its limitations.
Open interest alone doesn’t always differentiate between buying or selling pressure, resulting in a neutral indication.
Moreover, open interest alone can not explain the specific reasons behind market movements and market sentiment, and a wider investigation is always required, using both technical and fundamental analysis.
Open interest is a lagging indicator and doesn’t have any predictive capabilities for future market directions, getting less useful in non-trending markets. A misalignment between this indicator and fundamental market factors may result in misleading signals for traders.
For crypto traders, data can be unreliable when comparing across different crypto exchanges, necessitating individual exchange data analysis.
It is important to note how volume and open interest, together with price movements, can offer a more comprehensive understanding of the market, and this tool is never to be used as a standalone indicator.
FAQs
Open interest is the number of outstanding derivative contracts for an underlying asset. It keeps track of all the contracts that have not expired and are yet to be closed or exercised by the parties involved.
Open interest can tell you about the strength of a trend in the market. Increasing open interest confirms the trend while decreasing open interest suggests the trend is losing strength. It also reflects the long-term market sentiment and the subsequent level of interest or disinterest of the market participants in the underlying asset.
Open interest provides useful insights to both crypto and traditional traders, but, due to the highly dynamic and volatile nature of crypto markets, it must be used more carefully in this scenario.
Open interest is neither bullish nor bearish in itself but rather acts as a confirmation of a bullish or bearish trend. Increasing open interest data suggests a strong trend, while if open interest decreases it may indicate a weakening trend.
Open interest should always be used in conjunction with other indicators. In particular, it should be analyzed together with trading volume and price movements. It can give confirmation of denial of ongoing trends, or possible trend reversal.
Yes, they are different metrics. Trading volume represents the number of contracts bought or sold in a specific unit of time, and resets itself at the end of that time interval, while open interest keeps track of all the outstanding contracts, which remain open over a longer period.
