The term open interest refers to the total number of outstanding contracts for a given series that are to be delivered on a given day. Open interest is typically associated with futures and / or options contracts.
Option contracts require the participation of two parties: a buyer and seller. The seller is the party that creates the contract, while a buyer must be willing to purchase it. Taken together, the buyer and seller account for one contract. When discussing open interest, the term is referring to the total of all contracts of a given type that are expiring on a given day.
Investors in options will follow the variations in open interest, since it may indicate a change in the market's sentiment towards the underlying security or asset. Variation in open interest can also indicate a change in the overall investor sentiment towards a market. For example, an increase in the open interest in equity options is considered a bullish signal, while a decrease in open interest is considered a bearish signal. In the same manner, the lack of movement in the change in open interest is thought to signal the end of a bear or bull market. This relationship can be summarized as follows:
- When the stock market's prices are increasing, increasing open interest indicates a strong bull market.
- When the stock market's prices are increasing, decreasing open interest indicates a weakening bull market.
- When the stock market's prices are declining, decreasing open interest indicates a strong bear market.
- When the stock market's prices are declining, increasing open interest indicates a weakening bear market.