Options Open Interest: How It Confirms a Real Breakout in F&O Trading

Key Takeaways

1. Open interest shows the number of open contracts and volume shows the number of contracts traded during a session. They provide different information about market activity.
2. A price breakout accompanied by an increase in open interest and volume can provide additional confirmation of the market activity behind the move.
3. An increase in price with a decrease in open interest can indicate short covering, but it does not by itself confirm how long the price move will continue.
4. In f&o markets, looking at open interest across several sessions can provide more context than looking at just one day’s data. 
5. Make sure to check where the increased open interest occurs, whether it is in calls or puts at the strike price.

You have probably encountered such a situation when a stock or index breaks above an important resistance area. The price looks strong, but after a few days, it falls back below that level.

In such situations, the two figures can provide additional information: the options open interest and options volume. Each provides limited information, but together they can give more context about the price move.

When considered together, they can help you assess whether there is new positioning behind the breakout or whether the price move may have other factors behind it.

This blog helps you learn how these two go hand in hand for f&o trading.

What Is Open Interest in F&O Trading?

Open interest refers to the total number of open futures or options contracts outstanding for a particular strike or expiry that have not yet been closed out or settled. This differs from volume since volume indicates the number of contracts traded in one trading period.

When a new position is created, open interest increases. When an existing position is closed, open interest decreases. Therefore, changes in open interest can provide information about whether positions are being added or closed.

In f&o trading, this figure is tracked separately for calls and puts and also by strike price, which is why an options chain can show open interest for many different strikes. The basic principle remains the same though  it measures commitment, not just activity.

Why Volume Alone Doesn't Confirm a Breakout

Volume surges are obvious and often misleading. Volume spikes during breakout days can provide useful information, but there is no way of telling whether the volume action is creating new positions or closing off existing ones.

And here is an example that requires a bit of contemplation. The stock price crosses the resistance level with massive volume, and in one single day, goes up by 3%.

However, when you examine the options chain and see the open interest falling at that level, it can indicate that existing positions are being closed rather than new positions being created.

This means the rise in price should be viewed along with the option interest data rather than depending on price and volume alone. 

How Open Interest and Volume Work Together

By bringing these two readings together, four distinct scenarios keep coming up in f&o trading:

1. Rising price, rising volume, rising open interest. This combination may indicate that new positions are being created as the price rises. It can provide additional information when assessing a breakout.

2. Rising price, rising volume, falling open interest. The price is on the rise, yet the trades that are being done are those of position closings and not openings. This combination can indicate that positions are being closed, including covering of short positions. The price move should be assessed along with other market information.

3. Falling price, rising volume, rising open interest. This combination can indicate that new positions are being created as the price falls. It can provide additional information about the downward price move.

4. Falling price, rising volume, falling open interest. This combination can indicate that existing positions are being closed. It does not by itself confirm whether the decline will continue or reverse.

This combination can indicate that existing positions are being closed. It does not by itself confirm whether the decline will continue or reverse.

A rising options open interest figure alongside a price breakout can provide additional information when you are assessing a breakout  in f&o trading. 

You can read more on interpreting the options chain in mastertrust's guide to options chain analysis, which walks through strike-wise open interest in more depth.

Common Mistakes Traders Make While Reading Open Interest

A few habits show up repeatedly among traders new to tracking options open interest:

• Checking open interest only at the index level. Index open interest can provide useful information, but individual stock futures and options data can also provide information about a specific stock.
• Ignoring expiry-day distortions. Open interest can change as traders close or roll positions near expiry. This can affect how the data should be interpreted.
• Treating one day's data as confirmation. An increase in the number of open interests on one day does not mean that there will be a trend. Watching out for the indicator for two to three sessions will have more information.
• Not separating calls and put open interest. An increase in the total open interest may not provide enough information.  It is important to analyse which way the interest has increased.
• Assuming higher open interest always means more liquidity. Liquidity and open interest may correlate, but sometimes do not. Some strikes can have very good open interest despite very wide spreads between the buy and sell sides of the market.

How mastertrust Helps You Track Open Interest and Volume

mastertrust's trading terminal shows the open interest along with volume and price movements, which means you'll have all three metrics right in front of you at one time.

The cost factor is taken care of in such a way that the mastertrust takes Rs. 20/- per order charge for stocks, f&o and commodity deals. The cost pattern remains the same irrespective of whether you are placing an options order or making a spread of options. mastertrust does not take any account opening charges.

The first year of demat AMC is also free of cost.You can check the current account details on the mastertrust demat account page before you get started.

Index open interest can provide useful information, but individual stock futures and options data can also provide information about a specific stock.

Final Thoughts

The breakout signal alone will not be sufficient. Looking at changes in open interest along with price and volume can provide additional information about the positions being created or closed in the options market.

Looking at open interest along with volume and price can therefore give traders more context when assessing a breakout in f&o trading.

Frequently Asked Questions (FAQs)

1. What is the difference between open interest and volume in f&o trading?

The volume is the measure of the number of contracts that were traded in a session, whereas the open interest is a measure of the number of contracts that have not yet been settled or closed out. A high volume does not necessarily mean rising open interest.

2. Does rising options open interest always mean a bullish breakout?

No. An increase in open interest proves there are positions being accumulated, but it is also necessary to find out in which options  calls or puts  these positions are being built up and in the same direction as the price or not.

3. How often should I check open interest data during the day?

Open interests can be checked at different points during the session, especially when there is an attempt for a breakout. Open interest varies during the day.

4. Can open interest be misleading near expiry?

Absolutely. The positions tend to roll forward to the next expiry in the days leading up to the settlement process. This has the potential to affect the accuracy of the open interest numbers of the current series.

5. Is open interest more reliable for index options or stock options?

Both can provide useful information, but serve distinct purposes. The index open interest provides an indication of how the market is positioned, whereas open interest of a particular stock shows you what is happening in that particular stock.

6. Where can I check live open interest data while trading?

Open interest data can be available on trading platforms that provide options chain information. On mastertrust, investors can check the available options data through the trading platform.