Options volume and open interest quantify the activity level between buyers and sellers of an option’s contract. But, what’s the difference between the two?
Options volume defined
Volume is the number of options contracts traded on a given day. Volume is shown for each strike price for call and put options. Volume indicates investor demand and liquidity for an options contract. As volume increases, the bid-ask spread typically decreases, which leads to more efficient pricing.
Intraday volume is shown on most trading platforms. The volume count resets at the beginning of each trading day.
Open interest defined
Open interest is the total number of contracts outstanding. Open interest represents the active number of options contracts for a particular class, strike price, and expiration date that are open and have not been closed or exercised.
Open interest starts at 0 for every option contract. Open interest rises and falls throughout the the contract’s trading life.Open interest is updated daily and is typically displayed beside volume on an options chain.
Key difference between volume and open interest
Investors can trade the same options contract multiple times (volume). When a new contract is traded, open interest increases. Open interest can increase or decrease before expiration.
The difference between open interest and volume can be confusing. As a stock trader, you only have a single measure of liquidity and activity: volume.
Like stocks, options contract volume displays that day’s activity, whereas open interest is the total number of contracts outstanding.
Options traders must consider both volume and open interest because the two data points tell different stories.
Open interest only increases with new contracts
Option open interest increases when traders create new contracts that did not previously exist. This means that a new buyer must take a long position, and a new seller must take a short position. Together they create a new contract in the market.
Open interest decreases when buyers and sellers close their existing positions. The closing orders offset and reduce the contract’s open interest because that contract no longer exists.
Open interest example
Consider five traders labeled A, B, C, D, and E.
Trader A decides to buy a contract while Trader B decides to sell a contract. The result is the creation of a single brand new contract.
Trader C later also decides to buy five contracts at the same time that Trader D decides to sell five contracts. Just like the transaction between A and B, the new agreement creates five brand-new contracts. Now the total is six open contracts.
After two days of trading, Trader A decides to sell his contract. Trader B is not willing to sell his contract, but Trader D is prepared to sell one of his five. This results in a valid transaction and the closing of one contract. Open interest drops to five.
Finally, Trader E comes into the market and decides to buy five contracts from Trader C. Trader C already owns the contracts, so his sale helps fund the purchase for Trader E. Since there is not a newly created contract, open interest remains the same.
Why high open interest is good
High open interest typically means it's easier to trade the option because there are more market participants actively trading that contract.
The increased activity in the contract leads to better liquidity, so orders fill faster with tighter bid-ask spreads.
Illiquid options or stocks can be incredibly difficult to exit at a reasonable price, so a key “entry checklist” item is a minimum amount of open interest.
Higher open interest doesn’t necessarily mean smart traders are active in the contract. Higher open interest simply means there is higher activity or interest in that particular strike price.
Options volume vs open interest
Options volume is simply the raw number of contracts that have changed hands on a particular day, regardless of whether a new contract was created or not.
Volume can be higher than open interest.
For example, 10,000 contracts can trade on the day with an open interest of only 5,000, because contracts can trade hands multiple times without creating a new contract.
How does open interest and volume impact a trade?
Higher volume means higher liquidity. The more options volume there is for a contract, the more liquidity exists. These contracts are much easier to enter and exit because more market participants are transacting in the contract.
Open interest is also a sign of liquidity. Options trades are either opening or closing transactions.
For example, buying ten call options is an opening transaction. Selling those ten call options is a closing transaction. High open interest typically signals high liquidity.
How to use liquidity filters at trade entry
One of the first questions you should ask yourself before entering a trade is, “Does the ticker symbol or contract I am trading have enough liquidity?” If the trade doesn't have high liquidity, it could be difficult to enter and exit the trade efficiently, so why trade it?
Scaling into a trade with insufficient liquidity subjects you to slippage and poor fills. Slippage in low-liquidity options adds up and can cost you a lot of money.
Try to avoid thinly traded contracts and look for consistent high liquidity and open interest so that you can scale your portfolio in the future.
For example, round-numbered strike prices tend to attract significantly more volume. The $100 strike price for a security likely has more volume and open interest than the $99 strike price.
If you trade non-liquid options, you run the risk of not being able to close or adjust the position because the market is simply too small. Even if you can trade the contract, it may be priced inefficiently. It’s in your best interest to only trade securities with very liquid options.
With Option Alpha's autotrading platform, you can automatically filter for liquidity before opening a new position.
