What is Open Interest (OI)?

Open interest (OI) refers to the total number of unsettled derivatives contracts in a given market. OI changes only when contracts that did not previously exist are created or when existing contracts are closed. It increases when traders open positions and decreases when traders close positions.

All derivatives contracts are two-sided. There is one counterparty on either side of every trade. That is, each derivatives contract is comprised of a long and a short trader (i.e., a buyer and a seller). 100 OI = 100 longs and 100 shorts.

What’s the difference between OI and Volume? While OI refers to the total number of open derivatives contracts, volume refers to the total number of transactions that occur (i.e., the number of times a contract exchanges hands).

Calculating OI

OI is calculated by subtracting contracts that are closed from existing open contracts. Imagine four traders (D’Brickashaw, Ligma, Plaxico, and Johnson) are all trading the $SOL perp. D’Brickashaw and Johnson are both long, while Plaxico and Ligma are both short.

D’Brickashaw longs 26 contracts, and Ligma shorts 26 contracts. OI (Δ) = 26 | OI = 26 Johnson longs 50 contracts and Plaxico shorts 50 contracts. OI (Δ) = 50 | OI = 76 Ligma closes 7 short contracts, and Johnson closes 7 long contracts. OI (Δ) = 7 | OI = 69

What really happened when Ligma and Johnson sized down? Ligma and Johnson both settled 7 contracts. Ligma placed a buy-to-close order, offsetting his positions. Johnson placed a sell-to-close order, offsetting his positions.

Using OI to Inform Trading Decisions

OI sheds light on capital flows. Generally, increasing OI signals fresh capital flowing into the market, whereas declining OI signals capital flowing out of the market. Higher OI is naturally correlated with deeper liquidity.

Momentum traders often rely on OI transformations to validate market trends. Increasing OI is generally correlated with strengthening trends. Decreasing OI is generally correlated with waning trends.

Traders often juxtapose OI charts against price charts, as dislocations between the two charts can help inform trading strategies. OI flows provide traders with actionable market insights, particularly when looked at on a relative basis (i.e., along w/ volume and price).

Looking at OI, price, and volume to analyze market sentiment:

• OI ⬆️, Volume ⬆️, Price ⬆️ = Bullish 📈

• OI ⬇️, Volume ⬇️, Price ⬇️ = Bullish 📈

• OI ⬇️, Volume ⬇️, Price ⬆️ = Bearish 📉

• OI ⬆️, Volume ⬆️, Price ⬇️ = Bearish 📉

(remember, these are heuristics)

BTC/USD vs. BTC Aggregated OI

Looking back to Jan. 10th and 11th, we can see that a significant increase in OI precipitated the recent $BTC rally from the low $17k range to the mid $21k range.

SOL/USD vs. SOL Aggregated OI

Looking at SOL’s recent pump from the low teens to the low-mid 20s, we can see that OI increased dramatically from Jan. 3rd to 4th, and then price meandered for a few days before reaching escape velocity on Jan. 8th.

ETH/USD vs. ETH Aggregated OI

In the case of ETH’s recent price action, the OI and price charts follow a similar pattern from the start of the new year up until a massive gap up on Jan. 14th, at which point OI plummeted.

Conclusion

Open interest (OI) refers to the total number of unsettled derivatives contracts in a given market. I.e., the total number of derivatives contracts that have yet to be closed by an offsetting transaction or expiry-induced settlement. Ultimately, OI is one of many informative variables and can’t be relied on as a definitive indicator in isolation. Nevertheless, it is an invaluable metric for traders seeking valuable insight into trading opportunities that may otherwise go unnoticed.