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October 17, 2016 | 14:20 | Dubai
A term often confused with Volume is that of Open Interest. Simply put, it is the number of unsettled contracts within the derivatives market. Simply put open interest is the open number of contracts that remain open as on the end of the day – contracts that have not been exercised, offset or expired.
As an example,
Mr. ABC buys 100 Gold Futures on Day 1; Volume as on the end of the day is 500 while the number of open contracts is also 500. He was able to buy 500 contracts because there was someone on the other side selling the same. [Thus, here is is useful to note that a long and a short position taken together account for 1 open interest.]
The following day, Mr. ABC buys another lot of 100 Gold Futures. (Assume he’s the only participant in the market for this contract). So, volume for that day is 100; BUT, the number of open contracts rises to 200 (carried forward from the previous day). [Thus, volume is taken for each day independently but open positions are counted as a cumulative for the period of the contract).
On the 3rd day, Mr. ABC sells 50 Gold Futures. The volume for that day is 50. However, the number of unsettled contracts may fall to 150 (200 Long – 50 Short) or remain the same depending upon who purchased the futures from Mr. ABC. If what he sold was purchased by the same participant (he bought it from), then the open interest would get reduced to 150. But, if it was purchased by a new participant, then the open interest remains at 200. Why? That’s because, when the new participant purchased it, Mr. ABC still has 150 contracts (Buy) to settle, the 2nd participant has 200 (Sell) to settle and the new participant has 50 (Buy) to settle. The net effect is – open positions remain at 200.
Now, it is useful to know that as a single stand alone figure, Open Interest is of no use. Trader’s use it alongwith price changes and volume to make valuable interpretations. The below table is useful to gauge the same: