What are Options?
Options represent financial instruments that derive their value from underlying securities, such as stock, etc. These are common in options contracts, which offers buyers the opportunity to buy or sell the underlying asset. Options are different from futures which do not require the holder to buy or sell the underlying asset when they are not willing.
Options contracts come in various forms. Some of these contracts may include call options, which allow the holder to buy the asset at a predetermined price within a specific timeframe. Other contracts may come with put options, which allow holders to sell the asset at a predetermined price within a specified timeframe. Each option will have a maturity date before which holders must exercise the option.
Options contracts come with various other characteristics as well. Some key technical metrics can describe these characteristics, for example, open interest.
What is Open Interest in Options?
Open interest refers to the number of contracts that are active or not settled yet. These are common in options or futures contracts that show the number of options traders and investors hold in active positions. These are positions that are open but have not closed or expired yet, and neither have the investor exercised them.
Within an option contract, open interest decreases when contract holders and underwriters close out more positions than they have opened. For example, a call option has no open interest. After a day, an investor buys five options contracts as a new position. Therefore, the open interest in the call option at that time will be 10. A day later, the investor opens ten new positions while closing three existing ones. Therefore, the open interest in the option will become 12.
How does Open Interest work?
Open interest depends on options and futures contracts, and the relationship between buyers and sellers. For every option and futures contract, there will be a buyer and a seller. The relationship between both parties gives rise to that contract. This contract will stay open until one of the parties closes it. When one of these parties adds up the open contracts, which have a buyer and seller, it results in open interest.
When both parties initiate a new position in a contract, then its open interest will increase. On the other hand, if they both exit an existing position on a trade, the open interest will decrease by a contract. Both parties may also choose to transfer their current position to another buyer or seller. In that case, the open interest remains unchanged.
What is the importance of Open Interest?
Open interest is a metric used to measure market activity. When there are no open interests, it means that there are no opening positions or all positions have close. High open interest means that there are many open contracts, which means there will be more activity in the market. Open interest also measures the flow of money in the options market. Increasing open interest represents additional money coming into the market while decreasing interest means outflow of money.
Conclusion
Open interest is a common metric used for options, which are financial instruments that derive their value from underlying securities. Open interest represents the number of active contracts on a futures or options contract. Open interests on options contracts increase when the new positions get initiated.
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