5. Open Interest & Market Sentiment

When trading options, you’ll frequently hear about Open Interest (OI). OI is a measure of how many option contracts are currently active (open) in the market. It’s different from volume – volume counts how many contracts traded today, OI counts how many contracts exist (not yet exercised or closed). OI can provide clues about market sentiment and support/resistance levels.

What is Open Interest?

Open Interest is the total number of outstanding contracts that are open – i.e., not closed or settled. Each open trade (both a buyer and a seller) adds to OI, and when they close or expire, OI drops. For example, if trader A buys 1 Nifty call from trader B (opening new positions for both), OI increases by 1. If later one of them sells to someone else to close, OI might decrease (depending on whether positions are closed or transferred). The key is that OI represents open positions waiting to be settled.

Reading OI Data: OI is often shown alongside price. Many trading platforms and the NSE website display the OI at each strike in the option chain. Here’s how traders interpret it:

• High OI at a Strike: A strike with unusually high open interest can act like a magnet or a wall. For instance, if NIFTY 18,000 Call has the highest OI among calls, it suggests a lot of traders have positions there (often, a lot of them might be call sellers, expecting Nifty to stay below 18,000). This can imply resistance at 18,000 (many call writers confident Nifty won’t cross it). Similarly, a strike with highest put OI (say 17,500 Put) might imply support at that level (many put writers betting Nifty won’t go below 17,500). As a rule of thumb: highest call OI = resistance level, highest put OI = support level in the near term. Of course, these levels can break if there’s enough momentum or news

• Rising OI with Price Movement: If price of the underlying is rising and OI in calls is also rising, it could mean new long positions (people aggressively buying calls, or writing puts – both bullish signs). If price is rising but OI is falling (calls OI dropping), it might be short covering (bearish traders closing positions). Likewise, if the market is falling and put OI is rising, could be new shorts (buying puts or writing calls – bearish), whereas falling OI on a drop might indicate longs closing or short covering of puts

  

• Total OI and PCR: We often look at Put/Call Ratio (PCR), which can be based on OI. PCR = (Total Put OI) / (Total Call OI). A PCR > 1 means more puts open than calls (could indicate fear or hedging – often seen as contrarian bullish if extremely high, because too many people are bearish). A very low PCR (< 0.5) means calls far outnumber puts (could indicate complacency or bullishness – sometimes contrarian bearish if extreme). However, PCR interpretation is more of an art; moderate values are normal. Extreme values might signal overbought/oversold sentiment.

Market Sentiment from OI:

Open Interest essentially shows where market participants have placed their bets. Big jumps in OI at certain strikes often reflect institutional activity or strong conviction levels. For example, if suddenly the 40,000 strike BankNifty Call OI jumps by a huge number, possibly some institutions wrote a lot of calls there (bearish/bound view). High OI also means high liquidity at that strike, which tends to make those strikes battle zones – it may take a lot of force (new information or heavy buying) to push the market through a level with massive OI.

According to a trading article, “A high open interest suggests a greater interest from traders and possible support or resistance levels.” (What is Options Chain: Key Support And Resistance Levels). This encapsulates it well – OI is like seeing where the crowds (and big players) are standing.

Using OI Practically:

Many traders use OI charts or option chain data daily:

• They identify the strikes with highest OI for calls and puts – these give a quick gauge of support/resistance (for the current series).

• They observe changes in OI – for instance, if on a day of market rise, the OI of ATM call options actually went up, it might mean call writers are building positions (could cap the rally). If OI of ATM calls went down (short covering), it could fuel more rally as the headwinds are removed.

• OI Max Pain Theory:

  

  There's a concept called "Max Pain" which suggests that the market might gravitate towards a price where option buyers feel the maximum pain (i.e., most options expire worthless, benefiting option writers). This is calculated based on OI distribution. While some follow this as a predictor for expiry level, use it with caution – it’s more an observation than a guarantee.

Institutional OI Data:

In India, the exchange provides client-wise OI data (like how much FII, DII, retail, etc. positions in index options). For instance, if you see FIIs have a huge net short position in index calls, that indicates their stance. However, interpreting that is complex (they could be hedging stocks with calls, etc.). As a retail trader, focusing on overall OI and major changes is usually enough.

Remember:

OI is one piece of the puzzle. It should be used in conjunction with price trends, volume, and other indicators. It’s possible to get false signals (e.g., high OI at a strike that eventually gets steamrolled due to unexpected news). But generally, OI can validate trends (confirmation of breakdowns with rising OI can be meaningful) and highlight where the market expects a range.

Now that we’ve covered OI and gleaning sentiment, let’s turn to the more theoretical (but very practical) side of options: the Option Greeks – those Greek letters you hear seasoned traders talk about, which measure different sensitivities of option prices.