Understanding open interest in commodities

Open interest (OI) in futures and options (F&O) trading is one of the key parameters in determining price range of an underlying asset and interpreting the market sentiment for it. In this edition of Classroom, ET explains the significance of interpreting OI in relation to gold derivatives.

1. What is open interest in the commodity F&O market?

It refers to the outstanding, or open, position of traders on a futures or options contract. OI is a measure of the money that’s flowing into a market or an asset like gold, crude, etc.



2. What are futures and options contracts and how is OI calculated ?

A futures contract involves the purchase or sale of an underlying asset (say, gold) at a fixed price for delivery on a future date. If you are a buyer (trader A) and bullish gold, you buy 2 futures contracts. Another trader (B) similarly buys one contract. Now, a trader C sells them (A &B) all the three gold futures contracts. There are a total three contracts on buy and three on sell. So, the total OI is 3. If trader C wants to transfer 2 contracts, she buys them back from trader D. The total OI is still three because trader A has 2 long positions, B has 1 long position, C has 1 short position and D has two short positions. So, total OI is still 3 as no fresh positions are created. If D wants to sell two more contracts and A buys one and C, who wants to close out her sole short position, buys one from D, the total OI looks thus – A holds 3 longs, B holds 1 long, C holds zero, D holds 4 shorts. Therefore, total OI rises to 4.

The same works with options — with a call buyer being bullish and a call seller believing the price wouldn’t rise above the level sold plus premium received from the buyer, therefore being less bullish. Also, a put buyer is bearish but a put seller may not be that bearish as she thinks the price wouldn’t fall below the level sold minus the premium received. In the case of calls and puts, one looks at put-call open interest ratio to gauge the market mood. This will be dealt with in the next Classroom edition.


3. What is the relationship between OI and price?

There are four relationships that give a trader a clue into market sentiment by OI-price interpretation. Rising price accompanied by increasing OI signifies bullishness. Falling price along with increasing OI implies bearishness. Rising price accompanied with decreasing OI denotes short covering. And, falling price and falling OI means long or bullish positions are being liquidated.


4. Illustrate how looking at options one can arrive at a price range over a certain period?

Take front month gold options on MCX whose underlier is the gold futures contract. On Monday intraday, the front month futures price was ₹38,185 per 10 gm (contract size of gold is 1 kilo). The resistance based on gold call option with highest OI is ₹39,000. The support based on gold put with highest OI is at ₹38,000. So, the range until now and the options’ contract expiry on November 27 is ₹38,000-39,000 per 10 gm.