What is trading volume?
Trading volume refers to the number of option contracts exchanged by buyers and sellers in a given period (usually a trading day). It is monitored for individual securities and can also be summarized for stocks, sectors or entire markets. An option’s trading volume is calculated by the total number of deals traded during a specific time period. For example, if five investors collectively buy her 2,000 of a particular put-her option contract with the same strike price and expiration date, the trading volume of that contract on that day will be his 2,000. Join our options trading service for more information.
Why Trading Volume Matters
When an option is bought or sold or traded on an exchange whether it is a call or a put, it is considered volume. Simply put, an option’s volume is the number of contracts traded across a security or market in a particular timeframe (usually his one trading day). It is simply the amount of options that change from seller to buyer as a measure of activity. If a buyer purchases her 100 contracts from a seller or market her maker, the volume for that period increases by 100 contracts based on that transaction.
Let’s look at another example. Suppose Jim bought his 100 calls of XYZ Inc. (XYZ) in his October 30 strike. On the same day, Bill buys his 200 calls in the same strike and month. The total volume of his October 30th strike for XYZ is equivalent to 300 contracts (100 calls + 200 calls = 300). This result holds regardless of whether the XYZ call was traded by Jim or Bill. As you can see, option volume indicates the number of contracts traded at a particular strike price for a particular option on a particular timeframe.
Options volume is a useful tool for traders as it can point out where the trader is looking on an intraday basis. For example, XYZ Inc. reports strong earnings before the market opens and opens at a high price at the opening of the market. Call option volumes can be high as option traders try to take advantage of the rising stock price of the underlying asset. Conversely, a negative response to the same report could result in a spike in put option volume. However, if you didn’t know that XYZ Inc. reported earnings, but you knew that a large amount of trading volume in options was in the hands of stocks, it wouldn’t be possible for options players to speculate about some event or movement in stocks. You can see that As such, options volume is a useful indicator of events (known or unknown) surrounding a particular stock.
What is Open Interest?
Open Interest measures the total number of open contracts for a particular option. This includes all long positions held by an investor that have not yet been exercised, closed, or expired. Open interest is aggregated by option (puts are separate from calls) and can be aggregated by option type, expiration, exchange, or the entire listed options market. Open interest is updated nightly from all trades and posted the next day. Therefore, it does not change during the trading day.
After an option has been traded, open interest increases as investors take new positions. It then rises or falls on a given day as a result of new positions, closed positions, or options exercised on the previous day.
Open interest example
Consider the following trade orders routed by two different traders but on the same options contract.
Here, Trader A buys to open. Opens 5 contracts and Trader B sells to open 5 contracts. Both of these simple trading strategies are new positions.
If both traders fill the order, the option’s open interest increases by 5, as two traders have opened positions on the contract.
What happens when one trader closes a position and another opens a position? Consider the following trades.
As you can see here, Trader B bought 5 contracts to close and Trader C sold 5 contracts to open. In this case, the open interest remains at 5 as there are still 5 contracts open between traders A and C. However, if Trader A sells 5 contracts to close and Trader C buys 5 contracts to close, Open Interest is reduced by 5.
Therefore, Open Interest represents the number of option contracts open in the market between two parties, but we don’t care about the specific parties.
Why Open Interest Matters
When looking at the total open interest of an option, there is no way to know if the option was bought or sold. That is probably why many options traders ignore open interest completely. However, you should not assume that there is no important information there.
One way to use Open Interest is to look at it relative to the volume of contracts traded. If the volume exceeds existing open interest on a particular day, it suggests that trading for that option was very high on that day.
It also provides important information about open interest. Liquidity Optional. If the option has no open interest, secondary market for that option. If an option has a large open interest, it means there are a large number of buyers and sellers. An active secondary market increases the likelihood that an option order will be executed at a good price.
All other things being equal, the larger the open interest, the easier it is to trade that option with a reasonable spread between bid and ask.
For example, let’s say you look at Apple Inc.’s options and find that the open interest is 12,000. This suggests that the market for Apple options is active and there may be many investors in the market willing to trade. The option’s bid price is $1 and the option’s offer price is $1.05. Therefore, at mid-market prices he may be able to buy one call option contract.
On the other hand, suppose the open interest is 1. This indicates that there is no secondary market as there are few open interest in these call options and few interested buyers and sellers. Starting and ending with these options at the right price is difficult.
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Importance of option liquidity
Options volume and open interest are very important for options traders. Because I don’t want to get caught up in trading illiquid options (small and low open interest). Illiquid options tend to have wide bid-ask spreads, which can have a significant impact on your trading account. It becomes more difficult to get the price you are looking for, and as a result you are forced to accept a lower price if selling or pay a higher price if buying. Furthermore, if option orders are not executed in a timely manner, the price of the underlying asset may fluctuate, changing the parameters of the intended strategy. Active options traders view liquidity as a very important criterion in strategy selection and execution.
Additionally, when volume and open interest are low, it becomes difficult to exit an options position at a good price. This means that you cannot let go of your position, which can lead to large losses.
What are the ideal levels of volume and open interest? At a minimum, the options you use for your positions should have hundreds of volumes and thousands of open interest.
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Minimum daily volume: 100 seconds, preferably 1,000 seconds.
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Minimum open interest: 1,000 seconds.
At this point, you will understand the basics of volume and open interest and why they are important as an options trader. The following sections discuss which options on stocks tend to have the most of each option.
potential trading signals
Here is a summary of some potential volume and open interest trading signals to watch out for.
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If the price goes up and the call contract open interest goes up, it could be a bullish signal that buyers are establishing new long positions.
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If the price is rising but the call contract open interest is falling, it could be a bearish signal that the trader is losing confidence in the bullish trend.
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If the price is falling but open interest in put contracts is rising, it could be a bearish signal that traders are opening new short positions.
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If the price is falling, but the call contract’s open interest is also falling, call holders may be being forced out of their positions by margin calls.
Conclusion
Options volume and open interest are metrics that help investors better understand and interpret market movements in both the options themselves and the underlying asset. It also provides a gauge of option contract liquidity and how easy it is to open or close a position profitably. Both indicators have their limitations, but when combined with other data, they can help investors better understand option liquidity and make better informed trade choices.
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