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Interpretation of Open Interest charts to understand Market Trend:
Open Interest analysis can provide very useful insights pertaining market trend and support / resistance. It is very important for option traders to understand the relation between open interest and market direction. Combining interpretations from Open Interest (OI) and change in OI can give meaning results. Intelligent traders understand that even though OI is a very crucial ‘market indicator’, it should be combined with other technical indicators to get good results.
Open Interest to determine Support and Resistance:
Open Interest data can give very useful clues to determine Support and Resistance. e.g. if 11000PE has highest open interest, traders perceive it as important support for the current expiry. Keeping in view that most institutional investors write options rather than buy, the data helps to understand mood of ‘intelligent money’. Similarly if huge open interest is build for 11400 calls it will be seen as major resistance zone. If the expiry is near than the market may stay range bound between these two levels.
OI & Price Change Interpretation
|Increase in Price||Increase in Open Interest||Indication of new money coming and indicates further continuance of uptrend|
|Increase in Price||Decrease in Open Interest||Increase in price is due to short covering of positions|
|Decrease in Price||Increase in Open Interest||Decrease in price is due to newly build short positions and further weakness is predicted|
|Decrease in Price||Decrease in Open Interest||Traders unwinding their long positions by selling existing contracts|
While first and third scenarios of interpretation of open interest charts indicate direction of future market trend (Bullish in first case and Bearish in third Case), other scenarios does not indicate a clear trend. Traders can wait for clarity in open interest data or use other indicators to initiate positions.