Comment on Query of the Day

Nithin Kamath commented on 23 Aug 2013, 03:57 AM

A query asked here by SasiMenon, which was asked to entire Zerodha Team:

1. What do you mean by Open Interest (OI) in futures and options?

Futures and options are contracts and similar to any other contract it is a contract between a buyer and a seller. Buyer is bullish (expecting market to go up) and seller is bearish (expecting it to go down).
All such open contracts are together called as open interest. So if I have bought 1 lot of nifty expecting to go up and you have sold 1 lot to go down, that makes it 1 open contract and hence open interest of 1.
Typically every derivative contract will have its own OI, Nifty Aug futures will have its own OI and Sep futures will have its own. Similarly OI will be different for calls and puts of various strikes.

2. What would you infer if someone said “Nifty futures went down with a huge addition of OI?”

OI will go up when more people start participating or existing people start adding positions. According to OI theory, typically when a market is going in a particular direction and there is a huge addition in OI, this means there is more conviction in the move.
So if a market is falling and there is huge addition in OI, this would mean that the existing short positions who are making profits are adding more and hence the fall could be bigger. But understand that this is only theory and may or may not work like this in real.

3. What would you infer if someone said “OI on Nifty 5600 calls went up significantly?”

While trading options, money required to buy options is much lesser than what is required to write (sell first). So typically the people who write options are people having access to higher capital and hence the logic is that they are more proficient traders.
When OI for 5600 calls is going up, there are new buyers and sellers(writers) coming in and since the writer is more proficient trader as explained above, the belief is that he is probably right. So if he is right, his view is Nifty will probably stay below 5600 and hence he is writing the 5600 calls.
So if someone says OI on nifty 5600 calls has gone up significantly according to the OI logic it means that if nifty is above 5600 it might come below 5600 and if it is already below 5600, it might find it tough to go above 5600.

4. What would you infer if someone said “OI on Nifty 5400 puts went up significantly?”
Similar to as explained above, since OI is going up on 5400 puts and because option writer is probably more proficient, the belief would be that market won’t probably go below 5400 and if it is already below 5400 it might bounce back above 5400.
Hope this clarifies,
Nithin Kamath

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