How to read open interest and price movements

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Badrinarayanan K.S.

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Can you please explain the importance of open interest in option trading? What
conclusion can be made if we see an abnormal increase or decrease in open interest of a
particular option? - M.A. Samuel

Open interest is the number of options or futures contracts that are not closed or delivered
on a particular day. For instance, the current open interest for Reliance June futures
stands at 1,34,10,500; it means there are 53,642 long positions (1.34 crore units divided
by market lot, which is 250 for Reliance Industries) and as many short positions.

For an every new long position (buy) there should be a counterparty, who is in the short
position (sell). Assuming Y initiates a long position and Z takes up the short position,
together this long and short positions increase the open interest by one count. When both
the short and the long positions are closed, there is a decrease in open interest.

In the above example, if Y and Z close their positions, Y's long position is closed by short
position and Z's existing short position by buying a long position. As a result, the net
outstanding for Y and Z is zero. Because of this closure, the open interest gets reduced by
one contract.

However, there will not be any change in open interest if just one position is closed. For
example, Y initiates a long position and Z takes up the short position. After a while, if Y
closes the long position and the buyer is X. The new long position of X and the existing
short position of Z make one open position, resulting in no change in the open interest.

Significance: If the spot price and open interest of futures move up, it indicates a bullish
signal. If the price and open interest decrease, that also signal bullish outlook; a decrease
in price with an increase in open interest indicates a bearish signal; and similarly an
increase in price with a fall in open interest suggest a bearish outlook. However, these are
general rule. Only a close look at the price movement and open interest with a high degree
of involvement will help ascertaining the trend.

Please suggest the strategy on Bata India futures bought at Rs 495 and KS Oil futures
entered at Rs 27. - Pankaj Dhawan

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Bata India: The outlook remains positive for Bata India despite it is ruling near all-time
levels. The immediate support appears at Rs 467. As long as it holds, this level Bata India
can go up to Rs 548, according to Fibonacci projections. Only a close below Rs 373 would
change the overall outlook negative Bata India.

F&O pointers: The stock sees existence of short positions, as futures ended in discount at
Rs 495.25 with respect to close of Rs 499.50. Options are not active.

Strategy: Hold your position with a tight stop loss at Rs 462, if you can afford. If the stock
moves past Rs 510, you can switch the stop loss that level and hold it for a target if Rs
548.

KS Oil: The outlook remains negative for KS Oil futures even as the stock is ruling near all-
time high low level. The outlook would not change as long as it stays below Rs 34.3. It
finds an immediate support at Rs 25.3. If the current trend sustains KS Oils could reach Rs
21 and even Rs 18.

F&O Pointers: The KS Oils June futures added fresh short positions on Friday. Options are
not that active. However, a little cue provided by option trading indicates negative bias, as
27.5 call added open positions.

Strategy: Exit.

Please suggest a strategy to be adopted for Dish TV futures, bought at Rs 75. - Viswanath

Dish TV: The outlook is positive for Dish TV. It finds an immediate support at Rs 73.65 and
resistance at Rs 86. If it sustains the support level, it has the potential to reach Rs 86 and
even Rs 95. The stock finds crucial support at Rs 68.5.

F&O pointers: The Dish TV futures witnessed unwinding of long positions on Friday.
Options are not active. This indicates a narrow range for Dish TV.

Strategy: If you can afford, hold you position with a stop loss at Rs 73.65.

NOTE: The analysis and opinion expressed in this column are based on F&O data available
at this point of time and on technical analysis based on past price movements. There is
risk of loss in trading.

Feedback may be sent to > f&o@thehindu.co.in; or >blfuturesoptions@gmail.com

Published on June 05, 2011

TOPICS
stocks and shares

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