This is what I found out about open interest:
Options can tell us about the strength of future buying or selling. They clue us in when
we compare speculative put bets to speculative call bets.
Each day, the amount of open interest in equity options changes. A greater demand for
calls will prompt the opening of new call options, and the same is true of puts.
Therefore, a large amount of put open interest generally will indicate pessimism on the
stock price. We must also look at the prices of these options, because the open
interest could come from speculative writing of puts in the belief that the stock will
move higher. That happened with OEX options just before the 1987 stock market
crash. If there is a large put open interest and the put option prices are relatively
expensive, it can be said that there is demand for those puts. Demand for puts is a sign
of pessimism, which, if extreme, can suggest there is very little risk of selling pressure.
Such a stock is likely to move higher very soon after investors reach an extreme in
pessimism.
Large amounts of open interest can also provide support or resistance. Let's say XYZ
stock is in a trading range. Each time XYZ pushes up to the 100 level, it quickly
declines-falling until it reaches the 90 level, where it bounces and the cycle starts all
over again. In this scenario, 100 is a level of resistance for XYZ, and 90 is a level of
support. If there's demand for call options on XYZ at 100, well-heeled traders who
sold those options have a large vested interest in keeping the stock below that level.
They want the options to expire worthless, so they'll sell shares of XYZ stock near that
100 level in hopes of keeping XYZ below 100. This increased selling strength near the
100 mark is due at least in part to the activity of the option sellers counterbalancing
option speculators. It works the other way, too. At 90, option sellers sometimes have
the incentive to buy XYZ shares to prevent the puts from going in the money.
Volume is also important, because option activity can be either "smart money" or
"dumb money." Generally, laymen have much less information than do professional
investors and are correct far less frequently. If the volume of the option trades occurs
in small blocks-fewer than 10 to 20 contracts at a time-it's more likely to be laymen
who are wrong. Large, round-number blocks often come from professionals and are
more apt to be correct. We may or may not want to side with the professionals, but
we typically want to make trades in the direction opposite that of the speculators. |
