Using Open Interest in finding the trends

Options & Futures
1

Hi ,

 

I have a doubt in course in "TRADING USING OPTIONS SENTIMENT INDICATORS"

Total PCR =

Equity Put Volume + Index Put Volume 

------------------------------------------------------

Equity Call Volume + Index Call Volume 

 

My Qtn is :  Instead of Volumes what if we use Open Interest ..will give OI of PCR will same accuracy in finding trend ? 

 

means 

PCR =

Equity Put OI + Index Put OI

------------------------------------------------------

Equity Call OI + Index Call OI

 

Thanks in advance ..

 

 

2

Hey JayaPrakash P,

Let's assume, the instrument we are interested in is a Call Option ABC with strike price $50 which is expiring in one month. Since there are no contracts traded yet in this instrument, the volume is 0. 

Now, Investor X buys 20 call option contracts from a market maker (both initiate new positions).

Therefore, Trading volume = 20
Open Interest = 20

There is another Investor Y, who is selling 15 Call Options on ABC, X=$50. Now, the market maker buys the 15 call options to close his position.

Volume = 20 + 15 = 35
OI = 20 -15 + 15 = 20 

Since only one party (Investor Y) is taking a fresh new position and the other (market maker) is rounding his position, OI remains the same.

Hence, total Call Options bought are 35 (which is a bullish indication) but open call options are just 20 (a more precise bullish indication, since the market maker is just providing liquidity in the market)

Hence, PCR-OI may give results with more accuracy in this case but to interpret it is a little bit more complex than the regular PCR.

There is one more thing you can do i.e. use normal PCR and along with it, use OI to understand "trends" as you have stated.

Such that, 

1. If the market goes up, volume goes up, OI goes up and PCR goes down, then it is a strong market and profiting from a contrarian position (Selling at the top) may be a bit risky in nature.

2. But if the markets go up, volume goes down, OI also goes down and PCR is also going down, then profiting from this contrarian position (Selling at the top) is very likely to be profitable.

Hope this helps. Let us know if you have any other queries.

Keep Learning!!