Open Interest Analysis

1. What is Open Interest?

Open Interest refers to the total number of outstanding or open contracts (futures or options) that currently exist in the market. These contracts have not been squared off, exercised, or expired. Unlike volume— which counts total traded contracts for a given session—OI tells you how many active contracts remain open at the end of the trading day.

You can think of OI as the number of "open commitments" between buyers and sellers.

If two parties create a new contract, OI increases by 1.

If they exit or square off, OI decreases by 1.

If contracts are transferred between traders (one enters, one exits), OI remains the same.

This makes OI a direct indicator of market participation and trader conviction.

2. Difference Between Volume and Open Interest
Aspect Volume Open Interest (OI)
Measures Number of contracts traded in a day Total active contracts still open
Reset Reset daily Carry forward until expiry
Shows Activity level for that session Market participation and trend strength
Use Short-term momentum Trend confirmation and sentiment

Both volume and OI together provide a powerful market outlook.

3. How Open Interest is Created and Destroyed
OI Increases When:

A new buyer and a new seller enter the market.

New long and short positions are created.

OI Decreases When:

A buyer and seller close their existing positions.

Squaring off reduces outstanding contracts.

OI Remains Unchanged When:

One trader exits and another takes over the position.

Understanding these mechanics helps traders interpret market signals accurately.

4. Interpreting Open Interest with Price Action

The true power of OI comes when you combine it with price movement. OI alone is not actionable—its interpretation depends heavily on price behavior.

Below are the four essential combinations used in OI analysis:

A. Price Up + OI Up → Fresh Long Build-up (Bullish)

This means traders are entering new long (buy) positions. It shows confidence in upward momentum.

Interpretation:

Strong bullish trend

Buyers aggressively participating

Trend likely to continue

Used for: Swing trades, trend-following trades, and breakout confirmation.

B. Price Down + OI Up → Fresh Short Build-up (Bearish)

When the price falls and OI increases, it signals new short positions being created.

Interpretation:

Strong bearish sentiment

Traders expect further price decline

Downtrend gaining strength

Used for: Short selling strategies, bearish breakouts, continuation trades.

C. Price Up + OI Down → Short Covering (Bullish but Temporary)

As shorts exit their positions, OI declines, leading to a temporary upward price move.

Interpretation:

Rally driven by short covering—not fresh longs

Trend may not sustain

Usually seen before resistance breakouts or reversals

Used for: Intraday trades, profit booking zones, cautious buying.

D. Price Down + OI Down → Long Liquidation (Bearish but Temporary)

Longs square off their positions, reducing OI and causing price to fall.

Interpretation:

Weakness in bullish sentiment

Not necessarily aggressive bearishness

Might lead to consolidation or reversal

Used for: Stop-loss resets, exit signals for long positions.

5. Open Interest in Options Trading

Options (Calls and Puts) provide even deeper insights into market psychology.

Key Concepts:

Call OI shows resistance zones.

Put OI shows support zones.

Change in OI shows if traders are adding or unwinding positions.

A. High Call OI → Resistance Zone

Large Call OI means sellers are confident that price will not exceed that level.

Example: Bank Nifty 48000 CE highest OI = strong resistance.

B. High Put OI → Support Zone

Put writers believe price will not fall below this level.

Example: Nifty 21500 PE highest OI = strong support.

C. PCR (Put–Call Ratio)

PCR = Total Put OI / Total Call OI
This helps measure market sentiment.

PCR > 1 → Bullish (more Put writing)

PCR < 1 → Bearish (more Call writing)

Extreme readings indicate reversals

6. Open Interest and Market Structure

OI acts as a backbone for understanding the structure of trends.

1. In a Strong Uptrend:

Price makes higher highs

OI increasing

More long positions accumulating

2. In a Strong Downtrend:

Price making lower lows

OI rising steadily

Shorts dominating

3. During Consolidation:

Price range-bound

OI rises (indicating buildup for breakout)

Option writers dominate (call & put both increase)

4. During Reversal Signals:

Price moves opposite of OI direction

Divergences form

Indicates weakening trend

7. Open Interest in Futures

For futures traders, OI helps identify:

Trend strength

Reversal chances

Institutional participation

Liquidity zones

Breakout reliability

Futures OI Build-up Types:

Long Build-up

Short Build-up

Long Unwinding

Short Covering

Each type gives a specific trading opportunity.

8. How Institutions Use Open Interest

Smart money (FIIs, prop desks, institutions) uses OI to:

Hedge large portfolios

Accumulate positions silently

Trap retail traders in false breakouts

Control liquidity and volatility

Institutions track OI changes to understand where retail traders are vulnerable.

Example:
If huge Call writing appears before a breakout, it may be a trap to absorb liquidity before moving higher.

9. Open Interest as a Risk Management Tool

OI not only helps predict trends but also helps manage risk:

Avoids trading in low OI contracts (illiquid)

Helps identify expiry-week volatility

Shows where stop-hunts may happen

Indicates where option sellers are positioned

High OI zones act as magnets for price due to hedging flows.

10. How to Use OI for Better Trading Decisions
Step-by-Step Approach:

Look at price trend (up/down/sideways).

Check OI change (increasing/decreasing).

Identify build-up type (long/short/unwinding/covering).

Mark support and resistance using option OI.

Check PCR for sentiment direction.

Use volume + OI + price for confirmation.

Place trades near OI cluster levels for best risk–reward.

11. Limitations of OI Analysis

While OI is powerful, it has limitations:

Does not show whether buyers or sellers are stronger

Can give false signals during low liquidity

Options OI can create misleading levels before expiry

Sudden changes may be due to hedge adjustments, not trend

News-driven markets can invalidate OI-based setups

Therefore, combine OI with price action, volume, and market structure.

12. Conclusion

Open Interest analysis is an essential tool for understanding the psychology and commitment of market participants. By combining OI with price and volume, traders can identify trend strength, potential reversals, support and resistance zones, and institutional activity. Whether analyzing futures or options, OI serves as a reliable indicator for planning trades with precision. While it has limitations, when used with proper risk management and complementary tools, OI analysis significantly enhances trading accuracy and confidence.