Increase your Odds by Understanding Open Interest

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Increase your Odds by Understanding Open Interest
    
Open interest can be defined as the cumulative number of Futures or Options contracts that have not expired, been offset or fulfilled by taking or making delivery after the close of each trading day. Unlike volume that tracks each contract created during the trading session, open interest is the cumulative number of outstanding contracts that are held beyond the day session of trading. For example, if a trader turns a day trade into a swing trade by holding the position overnight, they may increase the open interest.

Open interest can be used as a confirmation tool to identify when a trend may be coming to an end or if the trend is sustainable by new money coming into the market. There must be a seller for every buyer of a Futures contract. What we will be looking for from open interest is will there be new buying or selling coming into a market to support the continuation of the current trend? When determining open interest of any given Futures market, we need only to know the totals from one side or the other, buyers or sellers, not the total of both. Therefore, the number you see posted as open interest is the actual number of outstanding Futures contracts and not the number of market participants.

Electronic trading has allowed the Futures exchanges to report volume in real time. Open interest, however, is always reported the next trading day (one day behind). This number represents the outstanding contracts from the previous trading day. Each day the open interest report will show the sum of all contracts still outstanding, along with a negative or positive number to indicate net changes to the sum of open interest.

The CME Group exchange releases these numbers at two different times of the day:

• 1:00 a:m EST (GMT +5) Preliminary Results
• 10:00 a:m EST (GMT +5) Actual Results

The preliminary numbers are estimates of open interest changes before the actual numbers are released later in the morning. These estimates prove to be fairly accurate unless there was some market event that caused excessive volume the previous day. On these days one may be better to wait for the actual numbers to come out before making any trading decisions based on open interest. If you would like to get these numbers directly from the CME Group, here are the steps:

1. Go to www.cmegroup.com
2. Go to "Featured Links" (right side of page)
3. Click on "Daily bulletins"
4. There will be a selection of different reports, you will be looking for "Summary Volume And Open Interest" for your related market (Indexes, Interest Rates, Metals, Energy, etc.)
5. Click on "View PDF"

Once on this page, you will be looking at the column "Overall Combined Total ñ Volume, Open Interest & Change." Look down the list of markets and see if your market had an increase or decrease in the number of outstanding contracts.

For every Futures contract that is traded, there is an impact on the cumulative value of open interest. There are three possible outcomes with each trade:

• If both traders are initiating a new position (one new buyer and one new seller), open interest will increase by one
• If both traders are off-setting their positions (one old buyer and one old seller), then open interest will decrease by one
• If a trader exits their old position and a new trader is on the other side (one old seller buys from a new seller) or (one old buyer sells to a new buyer), either of these events will cause open interest to remain unchanged

From the statement above, you may now be seeing how open interest can be of value to your trading. If you monitor open interest results, you can draw some conclusions about when new money is coming into a market, or when old money is leaving the market. Here is an example of new money coming into a bull market. As markets trend higher, you would like to see an increase (plus net change of open interest) on the days we make new highs for the trend such as breakouts to new highs. This would confirm new buying coming into the market. You are probably thinking that there is a new seller on the other side of that trade, too. If you were thinking that, congratulations because you are now beginning to understand the flow of money into and out of the Futures markets! Because we are in an uptrend (bull market), those new sellers will eventually become old buyers and have to cover their positions as the market moves higher.

Here is an important note about using open interest as a confirmation tool. Be careful on the day after a breakout and you see the open interest increase. We do not want to blindly buy the next day's opening price. The next day or two could see some price corrections back into a support level in case of an upside breakout. This usually happens because after the breakout and a large increase in new market participants, there are very few traders left to buy after them, therefore, the market must correct back to a support level where there will be more new willing buyers. You can reverse the above statement for a downtrend.

Table 1 will demonstrate how open interest should be interpreted:
    




Adding open interest analysis to your trading can help give you another view of the market in terms of money flowing in and out of it. As a market trends higher or lower, we would like to see new money coming in to support this trend. If the new money stops flowing into the trend, then the market will have a hard time continuing in that direction at which point you will see the open interest decline as a trend continues, and this will show weakness in the current trend.

On another note of the significance of open interest, if you are an exchange member (elite group of traders), you get the actual results of the open interest figures a couple of hours before they are released to the public. This would tell me that membership has its advantages and that perhaps we should be paying attention to this information if it is being given to the elite traders and firms first. Just make sure you use the information to support your decision to buy or sell on pullbacks after seeing this increase in open interest after a breakout or trend continuation.

"Each morning we are born again. What we do today is what matters most." Buddha

Trade well,

- Don Dawson
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