Trading using Open Interest and Volumes

Open Interest (OI) is the total number of outstanding contracts. It gauges the market participation. Open Interest is the number of contracts that are still open (i.e has not yet been exercised, closed/squared off, or not yet expired). OI increases when new contracts are created by option buyer and seller, where a new buyer takes a new long position and a new seller takes a new short position.

OI decreases when both the buyer and seller with existing positions close out their respective positions and the contract disappears. Closing of the contract happens either by an offsetting transaction or by exercising the option. OI increases only when new contracts are created. Hence, when a trader, who does not have a position in the option before, buys from another trader who has an existing long position and wants to close his position by selling his contract, OI does not change because no new contract has been created. 

Volume measures the number of contracts that exchanged hands during the trading session. It measures market activity. Volume reflects the number of contracts that changed hands from a seller to a buyer, regardless of whether it is a new contract being created or just an existing contract. Unlike Volumes, the changes in OI do not really convey any directional view on the markets. It does, however, give a sense of strength between bullish and bearish positions. The following rules summarise the trader’s perspective with regards to changes in OI and prices.