Open Interest is the total number of outstanding contracts that are held by market participants at the end of the day.
It can also be defined as the total number of futures contracts or option contracts that have not yet been exercised (squared off), expired, or fulfilled by delivery.
Open interest applies primarily to the futures market. Open interest, or the total number of open contracts on a security, is often used to confirm trends and trend reversals for futures and options contracts.
Open interest measures the flow of money into the futures market. For each seller of a futures contract, there must be a buyer of that contract. Thus, a seller and a buyer combine to create only one contract.
Therefore, to determine the total open interest for any given market, we only need to know the totals from one side or the other, buyers or sellers, not the sum of both.
The open interest position that is reported each day represents the increase or decrease in the number of contracts for that day, and it is shown as a positive or negative number.
Each trade completed on the exchange has an impact upon the level of open interest for that day.
For example, if both parties to the trade are initiating a new position (one new buyer and one new seller), open interest will increase by one contract.
If both traders are closing an existing or old position (one old buyer and one old seller), open interest will decline by one contract.
The third and final possibility is one old trader passing off his position to a new trader (one old buyer sells to one new buyer). In this case, the open interest will not change.
By monitoring the changes in the open interest figures at the end of each trading day, some conclusions about the day’s activity can be drawn.
Increasing open interest means that new money is flowing into the marketplace. The result will be that the present trend (up, down or sideways) will continue.
Declining open interest means that the market is liquidating and implies that the prevailing price trend is coming to an end. Knowledge of open interest can prove useful toward the end of major market moves.
When open interest is levelling off following a sustained price advance, it is often an early warning of the end to an up-trending or bull market.