Options volume and price movements in the stock market are reflections of decisions to purchase or sell by millions of options investors. However, the price isn’t the only piece of data successful investors monitor. Open interest and options volume are also important numbers to keep on eye on when buying and selling options. Understanding each of these numbers help investors make better-informed decisions when investing.

Key Takeaways

  • Options volume describes the activity level and liquidity of contracts in the options market.
  • Options volume refers to how many trades are completed making it an essential measurement of interest and strength of an option
  • Open interest refers to the number of options contracts held by investors and traders in active positions, or ready to be traded.

What Is Options Volume?

Trading volume calculates the number of futures or options contracts being exchanged between sellers and buyers. This identifies the activity level for specific contracts. For each seller, there’s a buyer, and each transaction counts towards the daily volume. When reviewing the underlying stock of an option, the volume provides investors insight into the strength of a security’s current price movement. Options volume, like with securities, can be used as an indicator of current interest.

  • Example: The volume for call option XYZ, having a strike price of $55 and expiration date three weeks away, didn’t trade any options contracts on a specific day. The options volume would be 0. During the next session, a trader purchases 20 call option contracts at the same time market makers sell 20 call option contracts. This lifts the options volume for this session to 20.

Why Options Volume Is Important

Traders look to options volume to determine the strength of an option. Higher volumes indicate increased interest in the options contract. A higher volume also results in increased liquidity, meaning it will be easier for investors to get out of a contract faster if needed.

It’s important to remember that options volume is relative and should be compared to the underlying stock’s average daily volume. A substantial change in a stock’s price combined with larger-than-normal volume is a good indication of market position in the way of the change. However, a considerable increase in price combined with lower trading volume doesn’t always mean strength. Many times, this combination indicates a coming price reversal.

Open Interest

Open interest shows how many futures or options contracts are currently held by investors and traders in active positions and haven’t been exercised, expired, or closed out. Open interest is a data field found on the majority of option quote displays, along with implied volatility, options volume, ask price, and bid price. Sadly, many investors ignore this information, which can result in unexpected consequences.

Open interest goes down when writers and holders of options, or sellers and buyers of futures close out their positions. To close out a position, they need to exercise their positions or take offsetting positions. Open interest will increase when sellers and writers take on new short positions or traders and investors open new long positions. Open interest will also increase when new futures or options are created.

When investors purchase or sell options, each transaction is recorded as either an opening or closing transaction. If an investor purchases 20 calls from XYZ, they are buying the calls to open with each call representing 100 shares or 2,000 shares in total. This purchase will add 20 to the open interest number. If the investor wants to get out of the position, they will have to sell those same options to close, making open interest fall by 20.

Selling options can also add to open interest. If an investor owns 2,000 shares of XYZ and wants to do a covered call by selling 20 calls, they would enter a sale to open. Since it’s an opening transaction, it will add 20 to the open interest. If they later wanted to rebuy the 20 options, they would enter into a transaction to purchase to close. Open interest then decreases by 20.

Keep in mind that not every transaction is counted in open interest. For example, if an investor buys 20 of the XYZ calls to open, and they are matched with a trader selling 20 of the XYZ calls to close, the open interest total number isn’t going to change.

Why Open Interest Matters

When investors look at the total open interest of a future or option, there isn’t a way to determine if the contracts were sold or bought. This is likely the reason most investors ignore open interest. However, they shouldn’t assume there isn’t important information to be found here.

One way investors can utilize open interest is by looking at it relative to options volume of traded contracts. When the options volume is more than the current open interest of any given day, it likely that trading in that option was unusually high for that day.

Open interest also provides investors important information concerning the liquidity of a futures or option. If there isn’t open interest in a future or option, there isn’t a secondary market for that product. When options and futures have a considerable open interest, it tells investors there’s a significant number of sellers and buyers available. An active secondary market improves the odds of getting futures and options orders filled at favorable prices.

  • Example: An investor looks at options on Alphabet Inc. and notices the open interest in 13,500. This suggests that the market in Alphabet options is active, and there are likely many investors in the marketplace wanting to trade. The option’s bid price is $2, and the options offer price is $2.10, meaning it’s likely they could buy a single call option contract at the mid-market price. However, if the open interest is three, it’s indicating minimal open interest for those call options with no secondary market due to hardly any interested sellers and buyers. This would make it difficult for an investor to enter and exit this option at favorable prices.

Options Volume and Open Interest Example

Here’s a more detailed look at the options volume and open interest measurements and how investors can use them in their trades.

Imagine it’s the day after expiration, and a new contract period, the June expiration cycle, is shown for option class LMN. An investor, Jack, logs into their online retail trading account and enters a purchase order to purchase 20 June 70 calls. The order is sent to the exchange and executes with Jill, a market maker from one of the U.S. options exchange markets.

Since this is the first day these options are available to trade, open interest is zero at the beginning of the day. Options volume will always be zero at the beginning of the day. Once the trade is complete, both options volume and open interest increases. Jack is long 20, and Jill is short 20. Therefore:

  • Options Volume: 20
  • Open Interest: 20

Later that same day, another party trades in the June 70 call series. Tom sells 15 calls, perhaps as part of a covered call. Jill is coincidentally the market maker buying the calls from Tom.  Since the trade occurs on the same day, the trade increases options volume by how many contracts traded. However, a new contract wasn’t established; it just switched hands. The two parties to the call are Jack and Tom, while Jill is flat, so open interest stays the same.

  • Options Volume: 35
  • Open interest: 20

The following morning options volume starts new, while open interest continues from the day before.

  • Options Volume: 0
  • Open interest: 20

Suppose that Jack decides to sell his 20-lot to close, and Jill repurchases hers at the same time, allowing them to trade with each other. Now, both Jack and Tom have no calls, so they are flat. 20 contracts switched hands, making options volume 20, and the existing contract is closed, so open interest is zero.

  • Options Volume: 20
  • Open interest: 0

Trading doesn’t happen in a vacuum. Indicators showing investors what other investors are doing can assist in their trading decisions. Open interest and options volume can help identify trading opportunities otherwise overlooked by investors. They are also beneficial in determining if options they are trading are liquid, allowing them to enter and exit trades quickly at the best price possible.

Learn more about options volume by downloading Jeff Bishop’s eBook, “The Penny Stock Playbook,” a step-by-step guide to mastering the market.

Author: Jeff Bishop

One of the best traders anywhere, over the past 20 years Jeff’s made multi-millions trading stocks, ETFs, and options. He is renowned as an incredible trader with a deep insight and a sensitive pulse on the markets and the economy. Jeff Bishop is CEO and Co-Founder of RagingBull.com.

Even greater than his prowess as a trader is his skill and passion in teaching others how to trade and rake in profits while managing risk.

Learn More

Related Articles: