The decisions of millions of investors result in the price movements in the options market. In addition to fluctuations in price, there are many useful statistics that can tell you what the other participants in the market are up to.
There are two elements to take into consideration when trading options: open interest in options, and daily trading volume.
Gain Insight Into The Market
Daily trading volume affords you critical insight into the power of the present market direction for the option’s underlying security. Market breadth, or the volume, is calculated in shares and expresses how significant the price change is in the market..
Remember, trading volume is comparative and should be likened to the average daily volume of the security in question. Look for a large percentage change in price that is accompanied by larger than average volume is a solid reading of market strength in the direction of the change.
Keep in mind that a large percentage increase in price that is accompanied by small trading volume is less likely to signal a market direction. They may, in fact, signal that a reversal is likely in the near future.
The Importance Of Open Interest
All options traders should understand the concept of open interest in options. It is always one of the data fields on most options displays – along side implied volatility, volume, ask price, and bid price – often, open interest goes largely ignored.
While it is true that open interest may be less critical than other factors in options trading such as the option’s price, or current volume, open interest provides useful information that a trader should consider before entering into an options trade.
Open interest represents the total number of option contracts that are presently open, or contracts that have not been liquidated by either an offsetting trade, or an assignment or exercise. This differs from stock trading where there are a fixed amount of shares to be traded.
When looking at the open interest for a security, you may be asking if the number represents the options that have been sold or purchased, and the answer is that you do not have a way of knowing for sure.
How To Use Open Interest
All buying and selling of options involves opening or closing a transaction. As options are opened and closed, the open interest will rise and fall accordingly. When you are looking at open interest in options, you do not have any way of knowing whether the options were sold or purchased. This is most likely the reason that options traders chose to completely ignore open interest.
You should not, however, take for granted that the open interest figure provides you with no critical information. Open interest is best used when considered against its relation to volume of contracts traded.
When the volume of contracts traded exceeds the existing open interest on a given day, suggesting that there was exceptionally high on that day. You can use open interest to determine whether there is unusually high or low volume for a specific option.
Open interest can also provide insight into the liquidity of an options contract. When there is no open interest for an option, this means that there is no secondary market for that option. A large open interest indicates a large pool of buyers and sellers, and an active secondary market.
Liquidity of capital, and receiving the best possible price for your option are the key factors in profiting from options. Utilizing these, and other market indicators puts you in a better position to realize gains from your investing endeavors.