Open interest and volume are two closely related topics in the world of options trading, so it makes sense to discuss them as a unified subject. Volume is already a familiar concept to stock traders, while open interest will likely ring a bell with those who have traded futures. Here, well learn how these concepts relate to the world of options.
Volume refers to all of the option transactions that took place -- whether at a given strike, on a specific stock, or within a particular series -- during a set time frame. Volume doesnt discriminate between opening and closing trades, so new initiations are counted alongside liquidations.
Therefore, if there are 50 opening transactions and 25 closing transactions at XYZs September 45 call on Wednesday, daily volume at that strike is 75 contracts.
Meanwhile, open interest refers to all of the outstanding option contracts that have been bought or sold to open, but have not yet expired or been otherwise closed out. Option contracts will remain counted in open interest until they are exercised, assigned, bought or sold to close, or expired.
So, lets say XYZs September 45 call currently has 50 contracts in open interest. On Thursday, 25 of those existing contracts are sold to close, while another 30 contracts are bought to open. These two transactions will result in volume of 55 contracts, but a net gain of only 5 contracts to open interest (30 newly opened contracts less 25 liquidations). Adding in the preexisting open interest of 50 contracts, the option now carries a total of 55 contracts in open interest.
Its important to note that open interest does not, in any way, describe the number of contracts available to trade on a particular option. New positions can always be bought or sold to open at a given strike, even if open interest is currently at zero.
However, if the daily volume on an option exceeds the number of contracts in open interest -- say, volume of 4,000 on open interest of 450 contracts -- its a safe bet to assume that a healthy portion of that volume will translate into new open interest the next day. Thats because, even if all of the existing 450 contracts in open interest are liquidated during that session, there are still 3,550 additional transactions occurring on that strike. Since you cant close contracts that were never open to begin with, most of the days volume likely consists of buy-to-open or sell-to-open transactions (although, in certain cases, its possible to see heavy volume evaporate overnight as a result of heavy day trading).
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