Volume vs Open Interest | Insight into Unusual Options Orders

If you're an options trader, then you know that trading volume and open interest metrics are two of the most important to watch. Volume tells you how much trading is happening in a particular security, while open interest tells you how many contracts have been created. Today, we're going to look at unusual options order activity and see if we can glean any insights from it. By understanding what's driving the action in specific securities, we can make more informed decisions about our trades!

Volume vs Open Interest | Insight into Unusual Options Orders
Volume vs Open Interest | Insight into Unusual Options Orders

Unusual Options Activity Explained

So what counts as an unusual options order? Typically, anything that falls outside the normal range is considered unusual. This could mean a significant spike in trading volume or open interest, or it could mean a sudden change in the type of orders being placed. For example, if you usually see a lot of buy orders for a particular

Option Volume Explained

Options volume is the number of contracts traded in a particular security. This metric is important because it can give you an idea of how much activity is happening in the active secondary market. If there's a lot of trading activity, then that means there's a lot of interest in the security. However, if daily volume suddenly drops off, that could signify that traders are losing interest in the security.

Option Open Interest Explained

Open interest reflects the number of open contracts that need to be closed for the particular option. This could be from option sellers (short positions) that need to buy to close or option buyers (long positions) that need to sell to close. This metric tells you how much demand there is for security, and it's essential to watch if you're trading options.

If open interest increases, more people will need to buy or sell these contracts in the future. This could provide future liquidity, giving the trader some confidence when entering.

In the example below, you can see SPY strike price option 11,000 contracts were traded for this one while the open interest is only 1,000.

Option Open Interest

How Volume vs. Open Interest are Related

Option open interest and daily trading volume are two key metrics traders use when assessing a particular marketplace's liquidity for options contracts.

A high level of open option interest generally indicates a lot of demand for traded options contracts. In contrast, a high volume suggests significant buying and selling activity. When both metrics are high, it usually signals that the market is in equilibrium.

Many active positions of options contracts shorted will need to be repurchased. So seeing a high number of short posts could provide extra liquidity.

A trader should pay close attention to the current interest and volume when looking to enter or exit a trade in a given period, as they can provide clues as to where the market is heading. These two metrics could help identify trading opportunities every single day.

What do low options trading volume and open interest indicate for contracts traded?

If you see low option open interest and trading volume, the options market for a particular asset is not very active, a neutral signal. On the other hand, low activity levels can indicate that traders are unsure about price movements and are nervous if they can buy or sell at their desired price point.

The lack of liquidity on the option chain will make it very hard to enter an order large. This lack of liquidity will also cause the trader to pay a contract premium. So traders must be aware of these moments, and open interest decreases.

When selling underlying positions, the same problem will occur. So when exiting and entering the same option with low option volume and low open interest, the trader will lose money twice. This will compound the losses making it harder to become profitable on the active contracts.

Traders must be aware of us well it is possible to be profitable in these scenarios. There is little room for error.

Benefits of high option open interest and volume

Open interest is an important metric to watch when trading options because it can indicate the market's liquidity level. When there's high open interest or an open interest increase, many traders are interested in buying or selling the option contract. This can lead to increased implied volatility and more opportunities for profits (or losses) same day.

As discussed in the example with low open interest and volume, the trader typically pays a premium for the contracts and sells them for a discount when trying to exit them. This could be an extra 10 to 30% lost just from entering and exiting at the potential price in terms of percentages.

The benefits to entering with high volume and high open interest mean greater liquidity, which means more percentage points added possible profit in the trade. This can significantly add up over time and make a massive difference for the trader long-term.

What does it mean when open interest is higher than the volume traded?

When you see that open interest is higher than the volume traded, many traders still have to buy or short option contracts and may need to exit in the future. This offers the trader lots of liquidity, leading to less money lost buying and selling these options. It is imperative to target liquid option chains as traders can quickly lose 20 to 30% at the mid-market price without open interest and volume.

We can see in the example below many large order options bought for the underlying stock have a high open interest. However, these are NOT considered aggressive orders from big money, so they are not as exciting for the retail investor to analyze and draw conclusions.

Low volume and high open interest

What do high volume and low open interest indicate?

High volume and low open interest usually mean a lack of liquidity in the market. This can lead to increased spreads and difficulty getting in or out of a trade at the desired price point.

These are pivotal moments where traders or large institutional investors pay a premium to buy the options. When large orders come in the market with low open interest on the option chain, it could indicate that smart money believes a significant move is coming in the underlying asset. That would be one of the reasons why they would pay premiums for options that have poor liquidity. They are paying an increased price now for the future potential because they believe something could happen.

High volume versus open interest example

In the example below, more contracts were bought on Tesla than open interest options for the trading day. The amount of volume option was 10,000 for most options, while the open interest was 1,000. This is a multiple of over 10! This is a highly aggressive call buying from big money.

This means that any new money market participants buying the option are paying a premium at this bid price because of the lack of buyers and sellers. This could also be an indication that there's an anticipated price movement coming. Many traders will look at this particular call option with a bullish bias on Tesla.

tsla open interest and volume example

Volume Affects on Unusual Options Activity

One of the most important things to remember when trading options is that volume affects the price. This is because options contracts are traded in pairs, with one side being the buyer and the other being the seller. So when there's more buying activity than selling activity, prices will go up. However, if there's more selling activity than buying activity, then.

Open interest Affects on Unusual Options Activity

Open interest can also affect price, but it's usually not as pronounced as the effect of volume. This is because open interest represents the total number of contracts that have been created for a particular security. So if there's more buying activity than selling activity, the open interest will increase, however, if there's more selling activity.

Volume Related to Open Interest

When looking at unusual options order activity, it's essential to look at both volume and open interest. This is because changes in either of these metrics can be an indicator of trader sentiment. For example, if the volume increases but open interest decreases, the traders are getting out of the security. Alternatively, if the volume is decreasing, but open interest is increasing, that could mean that traders are getting into the security. By understanding the relationship between these two metrics, you can better understand what's happening in the market!

Trading Volume and Open Interest

Now that you know what volume and open interest are let's look at their relationship. As I mentioned earlier, volume affects the price because it represents the number of traded contracts. When there's more buying activity than selling activity, prices will go up. However, if there's more selling activity than buying activity

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