Open Interest

Open interest refers to the total number of contracts open on any particular day. It is computed and provided by each exchange at the end of the days trading. Any single transaction in a futures market involves two parties and therefore results in two contracts being opened, one short or sold contract and one long or bought contract.

How to Use

The daily change in the open interest can be used as a measure of liquidity in a particular contract. Commonly the lead month futures contract changes every three months and therefore often a dramatic drop in Open Interest will occur as the lead contract changes. Some traders and institutions will leave bought and sold contracts open, in different accounts, rather than close them out, which tends to distort the absolute value of open interest reported. Nevertheless it's the change that is relevant and that should be the focus of our study.

Open Interest is best used in conjunction with volume. Simply expressed, if open interest increases as volume increases then we can say that the current trend, up or down, is likely to continue. Conversely a decrease in volume with a decrease in open interest may well indicate an end to the current trend.

It's also a way to gauge the strength of a move, more than just whether a market is accumulating or dispersing contracts. If price records a big up day, which is not accompanied with a similarly large volume day and an associated increase in open interest, then we can say that the move probably doesn't have the strength to continue. In fact, an up move associated with a decrease in open interest would suggest long liquidation or shorts being stopped out and therefore contracts being closed out.



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In the example above the top chart is a price bar chart, the middle line chart is Open Interest and the bottom histogram is volume. The period of unusually high volume during December is evidence of the roll to the next lead contract and hence we have to take this into account when looking at the dramatic reduction in open interest. What is interesting about this particular chart is that the open interest actually did peak just before price peaked and that provided an important signal indicating a change in trend. 

Since the expiry of the pervious contract open interest has started to increase as has price, volume has also been increasing and therefore we could conclude that the up trend may continue. The final data point shows a down day in price and volume, but an increase in open interest still. This supports continuation of the current trend to higher prices.

Disclaimer
© The MacLean Group Pty Ltd ACN 096 967 038. All rights reserved 2003. This article has been prepared by The MacLean Group and licensed to ASX. The views are those of the author and not of ASX. This material is educational and it is not intended to constitute financial advice.