Question

Distinguish between the terms open interest and trading volume.

Answer 1

Both open interest and trading volume can be tricky to understand but lets try to understand using an example so that it becomes more clear.

First, let's see what the terms mean.

Open interest means the number of contracts (options or futures) that are currently active and held by investors.

Whereas the trading volume represents the number of contracts that exchanged hands in a given period. It also includes settled contracts.

Example: On a given day, the previous balance of open interest or trading volume is zero. You bought 50 call options on the stock of Apple. The open interest is 50 and volume is also 50.

The next moment, you close 20 contracts, now the open interest is 50-20 = 30 whereas the traded volume has increased from 50 to 70.

So, while both open interest and traded volume signify the interest of investors towards a particular stock and its liquidity in the market.

One added technique that can determine bullish or bearish trend using open interest is that if the open interest is increasing and the share price is also increasing, this means a bullish trend, whereas if the open interest in increasing and the share price is falling, this means we can expect a bearish trend.