What Is Open Interest in Options? With Examples

Options contracts are financial agreements that provide the buyer with the right, but not the obligation, to either buy or sell an underlying asset at a predetermined price by a specified date. These contracts derive their value from an underlying asset, which can be stocks, commodities, or currencies. Options can be used for various financial purposes, including managing potential risks or speculating on future price movements. They offer flexibility, allowing investors to control a larger position in an asset for a fraction of the cost of owning the asset outright.

Defining Open Interest

Open interest represents the total number of outstanding contracts in a market at a given time. It measures the total financial commitment and participation within a specific derivative market. This figure indicates how many contracts have been opened but have not yet been offset by an opposing trade, exercised, or expired.

Open interest is created when a new buyer and a new seller initiate a contract, establishing a fresh position in the market. Conversely, it decreases when an existing buyer and an existing seller close out their positions. If an existing contract is transferred from one party to another without closing the underlying position, open interest remains unchanged.

Open Interest in Options Contracts

When applied to options, open interest specifically tracks the number of live, unexercised, and unassigned options contracts. Each individual option series, defined by a particular underlying asset, strike price, expiration date, and whether it is a call or a put, has its own reported open interest figure. For example, a call option for a specific stock with a $50 strike price expiring in March will have its own distinct open interest number.

This metric is typically updated at the end of each trading day, reflecting the net change in open positions. It provides a snapshot of the current number of active contracts that market participants hold.

Practical Examples

Understanding how open interest changes requires examining specific trading scenarios. Consider an option series with an initial open interest of 100 contracts.

If a new buyer acquires 10 contracts from a new seller who is initiating a position, open interest will increase. The total open interest for that option series would then rise to 110 contracts, reflecting the creation of new open positions.

Alternatively, if an existing buyer closes out 5 contracts by selling them to an existing seller who is also closing a position, open interest will decrease. In this instance, the total open interest for the series would fall to 95 contracts, as these transactions represent the unwinding of previously established positions.

In a third scenario, if a new buyer purchases 15 contracts from an existing seller who is closing their position, open interest remains unchanged. This occurs because one new position was opened while one existing position was closed, resulting in no net change to the total number of outstanding contracts. Similarly, if an existing buyer sells 20 contracts to a new seller who is initiating a position, open interest also stays the same.

Distinguishing Open Interest from Trading Volume

Open interest and trading volume are distinct metrics used to gauge activity in the options market. Trading volume represents the total number of contracts bought and sold within a specific period, typically a single trading day. It measures the frequency and quantity of transactions that occur over that timeframe.

Unlike open interest, which reflects outstanding positions, trading volume indicates the level of trading activity or turnover. Volume resets at the end of each trading day, providing a daily measure of market participation. Open interest, however, carries over from one day to the next.

How Open Interest is Used

Open interest data is commonly used to gain insights into market sentiment and the liquidity of specific option series. A high open interest in a particular option can indicate substantial market interest and a robust level of liquidity. This suggests that there are many participants holding positions, which generally allows for easier entry and exit from trades at competitive prices.

When open interest is increasing, it often signals that new capital is flowing into the market for that specific option, suggesting growing conviction among traders. Conversely, a decrease in open interest can indicate that existing contracts are being closed out, potentially signaling a reduction in market commitment or a shift in sentiment. Analyzing these changes helps market participants understand the depth of interest in an option and potential shifts in market direction.