Open interest is a concept that is unique to options. Volume is a parallel concept to stocks. First, what are they? Second, why should an options trader care about them?
Open interest is the number of active contracts. It is a metric that can be tracked or displayed on most options trading platforms, like bid price, ask price, volume and implied volatility, etc.. Yet, many options traders ignore open interest, which can lead to unforeseen consequences.
Trading volume is the number of shares or contracts traded in a given period, usually one day. When looking at the option’s underlying stock, that volume can give you insight into the strength of the current price movement. Trading volume in options, just like in stocks, is an indicator of current interest.
When you are looking at the change in total open interest of an option, there is no way of knowing whether the options were bought or sold. That’s probably why many options traders ignore open interest altogether. However, you shouldn’t assume that there’s no important information there.
One way to use open interest is to look at it relative to the volume of contracts traded. When the volume exceeds the existing open interest on a given day, it suggests that trading in that option was exceptionally high that day.
Open interest also gives you key information regarding the liquidity of an option. If there is no open interest for an option, there is no secondary market for that option. When options have significant open interest, it means there are a large number of buyers and sellers out there. An active secondary market increases the odds of getting option orders filled with reasonable bid/ask spreads.
Follow me on Twitter @MikeShorrCBOT