# What is open interest and how is it different from volumes?

If you have been **trading in futures and options**, you must have certainly come across the concept of open interest (OI). As the name suggests, the OI represents the sum total of futures and options that are currently open in the market. To see the example of OI in the live market, let us consider the futures of Reliance Industries as under:

When you open the futures or options price of any stock or index, you will find that the snapshot contains the total OI of the stock in that particular month contract. The OI in the red circled portion represents the OI in terms of number of shares. If you divide that by the lot size (1000 shares in this case), you will get the OI of Reliance May Futures in terms of number of lots. The change in OI (increase/decrease) is a very important parameter from an interpretation point of view for a trader. But first, let us understand how open interest (OI) gets created in the market.

**How open interest (OI) gets created in the market**

Let us start with a basic example of 3 investors in the market; A, B and C who are currently active in RIL Futures. On the first day, A buys 8 lots of RIL, B buys 10 lots of RIL and C sells 18 lots of RIL May Futures. The OI would look something like this…

Investor | Long on RIL May Fut | Short on RIL May Fut | Open Interest |

A | +8 | OI-Long 8 | |

B | +10 | OI-Long 10 | |

C | -18 | OI-Short 18 |

In the above instance, there are 18 lots long and 18 lots short. Since these are two sides of one trade the OI will be counted only once to avoid double counting. Hence the open interest of RIL May Futures will be 18 lots or 18,000 shares.

On day 2, let us assume that Investor D who is bullish on RIL decides to buy 20 lots of RIL May Futures. Investor A agrees to sell his 8 lots since he was making a profit. However, Investor B only agreed to sell half his lots. Another Trader E was willing to sell 7 lots of RIL May Futures as he expected the price to correct. Now how will the OI chart look like?

Investor | Long on RIL May Fut | Short on RIL May Fut | Open Interest |

A | +8 | -8 | 0 |

B | +10 | -5 | OI-Long 5 |

C | -18 | OI-Short 18 | |

D | +20 | OI-Long 20 | |

E | -7 | OI-Short 7 |

Now comes the interesting part about the open interest change. As can be seen from the above table, the OI on RIL May Futures is now at 25 lots. That means over the first day, the OI has increased by 7 lots (25-18). Why is the increase in OI only 7 lots when D has actually acquired 20 lots. The answer is quite simple. Out of the 20 lots that D bought, 13 lots came from A and B. So D’s increase in open interest was negated by the reduction of OI in case of A and B. It was only the remaining 7 lots that created a fresh position by E and that increased the open interest. That is how open interest keeps getting built and diminished over time. At the end of expiry, the OI will automatically stand at zero as futures and options that are not reversed will automatically be closed by the exchange.

**How to interpret shifts in Open Interest (OI)**

Open interest alone is not a substantive criteria to evaluate in isolation. But OI does give some hints when it is combined with the stock price. Here is how…

- When open interest of stock futures is rising along with rise in the price of the stock, it can be interpreted as a bullish signal as long positions are being built.
- When open interest of stock futures is rising with a fall in the stock price, it is a negative signal as fresh short positions are being built up in the stock futures.
- When open interest of stock futures is falling with fall in stock price, then it is a mildly negative signal that there is unwinding of long positions and could be a neutral outlook.
- When open interest of stock futures is falling with rise in stock price, then it is a mildly positive signal as it can be interpreted as short covering in the stock.

To conclude, open interest has to be understood as distinct from volumes. For example, if I buy 100 lots of Nifty and sell the 100 lots of Nifty on the same day, then volumes will increase by 200 lots but an impact on OI will be nil.