In Part 8 of Patterns & Profits Cash Course, we’re going to focus on 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.
And it’s incredibly easy to understand.
Here’s how it works…
Why Checking Open Interest Should be Part of Your Daily Routine
Open interest (O.I.) is rarely looked at. But it should be…
It’s defined as the total number of options contracts for a particular strike that are “open,” both long and short. Now this is not to be confused with “volume.” And although, you may have heard the two used in tandem, O.I. and volume are different. We’ll talk about volume in a moment.
O.I. is exactly what it sounds like – the interest in an options position. O.I. increases or decreases depending on the number of traders entering and exiting trades. But remember that for every options contract, a buyer and a seller are required. O.I. is represents the increase or decrease in the number of contracts that particular day, either as a positive or negative number.
O.I. can be high, low, or nonexistent. When O.I. is high, it means there’s a large number of buyers and sellers active in the market. When it’s low, it means there’s a small number of buyers and sellers active in the market. And when there’s O.I. is nonexistent, it means there’s no active market for that particular options trade. The higher the O.I., the quicker – and cheaper – it is for you to get in and out of your trades.
Let’s take a look at the stocks with the highest open interest in the market right now, compliments of Optionchart:
NVIDIA Corporation (NVDA) has the highest open interest in the market right now – specifically the NVDA September 20, 2024, $280 puts – which means there are a LOT of traders interested in NVDA right now:
In some charts, you’re also given a “Change” column that shows you if the O.I. has increased, decreased, or remained the same. This can tell you if a trend is forming, reversing, or staying the same. 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:
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:
While you can check with your broker to track this data for you, there are plenty of free sites like the Yahoo! Finance Options Center, Barchart, and Optionchart where you can find this information yourself.
But I’ve got my own AI-based tools that track open interest, high volume, unusual volume, cheapest options, most expensive options – and MUCH more…
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AFTER taking an 80% profit on the second-largest car insurance company in the U.S. on Monday…
All thanks to hidden, short-term patterns my software’s able to identify on the best stocks and exchange-traded funds (ETF) in the market.
And on Monday, August 26th, I’m releasing my next recommendation that could double your money or more – in only 30 days or less.
To your continued success,
Tom Gentile
America’s Pattern Trader