Finance Monthly - December 2022

53 Finance Monthly. Inve s tmen t How Open Interest is Used by Traders? When a TV personality says that open interest rises for a particular stock, they mean there are more “buy to open” positions. Inversely, if they say that open interest is decreasing, they mean there are more “buy to close” positions. More importantly, in addition to counting the total number of options contracts, open interest tells us the number of puts vs. the number of calls. In the case of Meta (META) on October 31st, such ratios look like this: Because there are far more calls than puts for META shares, we can see that investors expect the stock to rally. Yet, one should not conflate these ratios into thinking that such open interest is either bullish or bearish. Whether put or call open interest overshadows the other, it just means that investors expect such outcomes. Open Interest vs. Trading Volume In both DeFi liquidity pools and TradFi stock exchanges, liquidity is critical to trade at the most favourable price. If the trading volume is low, it would be more difficult to find the right selling or buying price because the gap between asks and bids would widen. Conversely, in the options market, a high trading volume would make it easier to close or open contracts at favourable positions and premiums. With that said, trading volume could falsely portray market activity. For example, a single institutional whale could spike trading volume, creating an illusion of market liquidity. Additionally, open interest should not be confused with trading volume. If traders sell 500 options to new traders, open interest would remain the same because open and closed positions would cancel each other out. But it would mean that the trading volume increased. Both puts and calls volume are expressed as a percentage change from the last trading session. Open Interest vs. Trend Strength As open interest increases, market liquidity increases as well. In turn, rising liquidity suggests the strength of that momentum, regardless in which direction it heads. For example, if META stock declines in price but open interest keeps rising, it would indicate further META fall. Inversely, if META stock rises alongside open interest, it would indicate further stock rise. For this reason, open interest-based momentum - acceleration or deceleration - is often used to indicate a momentum turnaround. These momentums are expressed as the true strength index (TSI), relative strength index (RSI), average directional index (ADX), andmoving average convergence divergence (MACD). Why Open Interest Counts At the end of the day, both stock and crypto markets gauge the allocation of money. On top of that layer is the derivatives market, providing space for potentially profitable speculation through factors such as the max pain point in options trading. Because open interest measures derivatives activity, as puts and calls, it can be used as an indicator on which side the speculation lies. Combined with trading volume and strength momentum, open interest then shows when to exit or enter market positions. Put Volume Total 7,981 Call Volume Total 12,445 Put/Call Volume Ratio 0.64 Put Open Interest Total 88,122 Call Open Interest Total 239,611 Put/Call Open Interest Ratio 0.37

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