The Beginner’s Guide To Option Open Interest

open interest

The beautiful thing about the options market is that it’s as big or as small as we (the traders) make it. When it comes to open interest, each expiration starts with the same amount of contracts – ZERO.

What Is Open Interest?

Simply put, option open interest is the open number of contracts that remain for an expiration month. This includes contracts that have not been exercised, offset, or expired.

It’s pretty standard that beginning traders confuse open interest with volume. As a stock trader, you only really have a single measure of liquidity and activity which is volume.

However, as options traders, you have to consider both volume, AND open interest as the truth is that they are completely different data points.

Let’s explore.

Open Interest Only Increases With New Contracts

When traders create brand new contracts, which did not previously exist, option open interest will increase. This means that a new buyer must take a long position and a new seller must take a short position. Together they create a new contract in the market.

Open interest can decrease if both the buyer and the seller close their existing position. In this case, the single contract that they had between each other would terminate and reduce the market’s open interest.

Let’s Go Through An Example

So, in this example, we have five traders who are labeled A, B, C, D, and E.

Trader A decides to buy a contract at the same time that Trader B decides to sell a contract = the result is the creation of a single brand new contract.

Trader C later also decides to buy five contracts at the same time that Trader D decides to sell five contracts = just like the transaction between A and B, the new agreement creates five brand new contracts. Now the total is six open contracts.

After two days of trading A decides to sell his contract. At the time B is not willing to sell his contract, but D is prepared to sell one of his five = this results in a valid transaction and the closing of one contract. Open interest drops to five.

Finally, Trader E comes into the market and decides to buy five contracts from C. Trader C already owns the contracts, so his sale will help fund the purchase for E = since there is no newly created contract, open interest remains the same.

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The Only Benefit of Open Interest

In reality, the only real benefit I see in open interest is the ability to trade a more active contract. The increased liquidity helps fill orders faster and at smaller bid/ask spreads. If you’ve ever traded an illiquid option or stock, you know first-hand how hard it is to get out of the position (let alone at a decent price).

Some people incorrectly assume that higher open interest means smarter traders – not right. Higher open interest just means that – higher activity and interest in the particular strike. Remember that one contract means you have a buyer AND a seller and they both can’t be THAT smart.

I Understand Open Interest – How Does it Fit With Volume?

If you’ve followed me this far, you probably have a real good idea about what open interest is and isn’t. Just for the sake of clarity let’s make sure you still understand volume as it relates to options trading.

For options, volume is simply the raw number of contracts that have changed hands on a particular day. This is irrelevant of whether a new contract was created or not.

This might explain why you might see a large volume of say 10,000 contracts on the day but open interest of just 5,000. Well, that’s because some of the contracts that were traded must have been closed out before the end of the day.

What does it mean if there is no Options Open Interest?

I lot of people have asked what it means if there is no open interest showing up in any of the contracts. The reason that there is no open interest showing up sometimes is that open interest is calculated after the close of every trading day. It’s recalculated for the next day. Whenever you see open interest on the platform, it will be for the last trading day.

In a case where the contracts just started trading today, there will be no open interest because there’s nothing before today trading. But if you wait a day or two you’ll start to see some of the numbers flow over into the open interest category and they’ll start to build up some open interest.

Check this topic out in more detail by watching our free video here.

If you sign up to our Watch List, you can see all trades and their open interest to help you make your choices and have a look at our Answer Vault for questions other people have asked about open interest.

Tracking Open Interest

I’m going to leave this question in the comments section below. Most traders think that open interest is always posted live on the quotes tab of your broker platform – but that’s incorrect. It’s posted completely different that you might have thought before.

Take a stab at guessing why the final figures are not shown live throughout the day by adding a comment below.

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and two daughters.