Comment on Query of the Day
commented on
24 Aug 2013, 07:37 AM
In continuation of the above query on Open Interest, follow up questions from one of our clients:
1. If I sell 2 lots and there are 2 people X and Y who have bought 1 lot each, assuming we are the only people trading the contract, the OI is 2. What happens if X who has bought 1 lot sells it to another person Z, what is the OI now?
When X sold the lot he had bought from you to Z, a new contract was not created; the existing contract just changed hands so the OI will remain two. But if Z bought say 1 lot from anyone other than X and Y, then that would be a new lot and hence the OI will now go to 3.
Since in the query above a new lot was not created, the OI remains at 2.
2. Secondly as per your earlier post for OI on futures, if market is going down and OI is increasing you said the market could go even lower because of the OI logic. But aren’t both the buyers and sellers increasing, why can’t we look at that new buyers are coming in so market might reverse?
Assume the OI is presently 10 on Nifty futures and nifty is at 5500. This means there are 10 lots long and 10 lots short. Market came down to 5400, so the buyers together have a loss of 50,000(10x 5 lots = 500 nifty x 100 points = 50,000) and the people who are short have profit of the same.
At 5400, OI went upto 20, basically doubled. When OI went up, either the people who were holding positions from before added or new people came in and bought and sold lots, if you were looking at all of this, which side would you want to be on, long or short?
Understand that at 5400, longs are sitting at 50,000 loss and are weak and shorts are sitting on 50,000 profits and are stronger. The most important logic to make money in the market is to be with the trend, be with the person/stock who is stronger. That is why we infer that if OI went up significantly when market goes in a particular direction, the direction might continue for much longer.
3. Logic behind assuming that if 5600 calls OI went up significantly, markets might not cross 5600?
Let me give you an example, assume you are sitting in an exam on financial markets and there are 2 people sitting next to you, one is Nithin who has almost 15 years of experience in the domain and on the other side is this boy called Siva who is just 2 years in the business and still confused about what the business is all about, if you had to copy, from whom will you Nithin or Siva? 🙂
The whole theory of Open interest conspiracy on options is based on the fact that the buyers of options are mostly retail who are probably not experienced(similar to Siva in the above example) and the sellers/writers are institutions who are more proficient and have been doing it for a while( like Nithin). So if you had to bet on who is right, whom would you now?
So when 5600 calls OI is going up, there are new buyers and sellers coming in and since sellers are more proficient traders we assume that they are right and hence market may not go above 5600.
This is all a theory and may or may not work in real life, but we at Zerodha proprietary trading desk believe it works and are also planning on a tool to help all our traders to track the OI to know what direction the professional traders are in.
Rock N Roll,
Nithin Kamath