Today we need to talk about an extremely important – and commonly misunderstood -number in the options market.
Not only can it tell you when a trend is forming or unwinding…
It could also help you navigate your open positions.
It’s so important, in fact, that it should be checked daily because it can also help get you in and out of your trades faster.
You can see in the chart above that the Bank of America Corporation (NYSE: BAC) January 17, 2017 calls, for example, are at the top of list when it comes to high O.I. This means that there’s a large number of traders interested in these calls.
However, you can see in the “Change” column that the O.I. for this options trade increased by 0.3% since the O.I. was last reported. And that could indicate that a trend is changing – whether forming or reversing. An increase in O.I. with an increase in price could indicate an upward trend while a decrease in O.I. with a decrease in price could indicate a possible reversal.
Now there’s really no way of knowing exactly who’s on what side of a trade simply by looking at O.I. It’s also difficult to determine the exact cause for a large bump or drop in O.I. on a trade. But O.I. is one of the best tools you can use to determine the liquidity of your trades.
Liquidity is the ease with which a market can be traded. Liquidity is what allows you to get your trades filled easily – and it’s what allows you to get out of them quickly. More open contracts means higher liquidity while less open contracts means lower liquidity. Higher liquidity makes it easier for you get your orders filled and quicker for you to exit your trades. Lower liquidity makes it harder for you to get your orders filled and slower for you to exit your trades.
Be Careful Not to Confuse O.I. with Volume
Now I mentioned above that O.I. is not to be confused with volume – and this is a very common mistake in the trading world.
You can use O.I. to determine liquidity, which is essential when it comes to moving on your trades quickly. You can also use O.I. in tandem with volume to determine liquidity. Unlike O.I., which is the number of contracts in the market, volume is the number contracts (or shares for stock positions) traded in the market for the day (or other specific period of time). An increase or decrease in volume could also indicate forming or reversing trends in the market.
Most places that track open interest also track volume, like the Yahoo! Finance Options Center:
By checking volume, you can also determine the liquidity of the market and use that information to pull the trigger on your trades – or trades you might be interested in. As a rule of thumb, it’s better to use markets that trade at least 300,000 shares a day, although one million shares a day is even better.
How You Can Interpret and Track O.I. and Volume
As we discussed earlier, O.I. – and volume – can give you a sense of a forming trend or a reversal. An increase in O.I. with an increase in price could indicate an upward trend while a decrease in O.I. with a decrease in price could indicate a possible reversal.
This is an extremely simple chart you can print and keep at your computer to determine a possible trend or reversal using O.I., volume, and price:
||Market is Strong
||Market is Weakening
||Market is Weak
||Market is Strengthening
As you know, the Yahoo! Finance Options Center tracks O.I., volume, and price. Many other options and financial websites let you track open interest as well as volume, including the Options Clearing Corporation (OCC), http://www.optionsclearing.com/webapps/daily-open-interest.
You can also check with your broker, but you could save yourself the time – and calls – by tracking it on your own.
Whatever method you use, O.I. could make or break your trades and is worth taking a few extra minutes every day to check.
Have a great weekend!