Mastering Options Trading: Decoding Open Interest Vs Volume

In the realm of options trading, two metrics stand as sentinels: Open Interest and Volume. They help reveal the ebb and flow of market sentiment. With their wisdom, you’ll navigate these waters with the poise of a seasoned mariner.

Ok, enough of sounding like Hemingway there. Let’s begin!

Decoding Volume vs. Open Interest in options

Understanding Open Interest vs Volume

When looking more closely at Open Interest and Volume, you can learn really useful stuff about the stock options you’re working with.

If you open the options chain in your broker account, you’ll see Open Interest and Volume numbers for each option.

These numbers tell you how many people are interested in a specific option and how active it is. It’s like getting the inside scoop on how much attention an option and your stock is getting. Essentially then, it tells you how liquid a given options is.

Exploring Options: Volume and Open Interest

Let’s break it down using an example. Imagine you’re looking at the October covered calls for Tesco, a big retail company. Among those, the October 235p strike calls show an Open Interest of 400 and a Volume of 2. This means there are currently 400 active contracts for this option, and on the most recent trading day, 2 contracts were traded.

Now, shift your focus to Apple Inc., a massive tech company that’s a key player in many investment portfolios. When you check out the Volume and Open Interest for Apple’s options, you’ll notice something interesting. The Volume and Open Interest columns have way more numbers, showing a much higher level of trading activity compared to the options of Tesco.

The Significance of Volume in Options Trading

At its heart, liquidity in the options market is all about how much trading is happening – specifically, the amount of trading and how fast those trades are going through.

This is where Volume becomes important. Volume shows us how many option contracts have been traded in a certain period, usually just one trading day.

Think about a situation where an option has high Volume. This tells us that a lot of traders are actively buying and selling that option.

This active trading helps make the market more liquid, and that leads to smaller differences between the buying and selling prices.

AUTHOR'S NOTE - THE BID / ASK SPREAD

The differences in prices that you see in the options chain are called the bid-ask spreads. The bid is the highest price a buyer wants to pay, and the ask is the lowest price a seller will take.

If you look at some UK stocks such as TSCO, GLEN, BP. STAN to name just four, you will notice some disparity between the bid and the ask price. 

When there's more liquidity from higher Volume, it's easier for traders to find someone to trade with, whether they're buying or selling options. This makes it smoother to get good prices and complete trades quickly.

When placing trades with wider bid / ask spreads it's good practice to use limited orders. Start high, more at the ask price, and then walk it down. 

Usually somewhere between the two prices in the middle is where the order will get filled. But better to start high and try get filled at a higher price.  

Demystifying Open Interest and Volume in Options

Open Interest, on the other hand, gives us a different angle on options trading.

Instead of looking at the day-to-day trades, Open Interest gives us the total number of active contracts for a certain option.

It shows us the bigger picture of how much traders are really into a specific stock option.

When an option contract is first sold (or written), it becomes part of the Open Interest count. As time goes on, more contracts might be sold, adding to the Open Interest count.

But, if option contracts are used or balanced out by opposite trades, the Open Interest count goes down.

Imagine you’re thinking of selling a cashed secured put option on Apple Inc that has a lot of Open Interest. That means many traders have invested in that option, which shows there’s a big amount of interest and trading going on.

Basically, Open Interest tells us how much traders are really dedicated to a certain stock option.

The Role of Liquidity in Trading Strategies

As option traders, how easily we can trade – shown by Volume and Open Interest – really affects how well our trading plans work. Different plans need different levels of trading to be successful.

If you are an options trader that works with more monthly vs weekly timeframes and rarely looks to buy back their positions early, then seeing lots of open interest and volume might not be that important to you.

The rationale behind this approach is to retain the option until expiration. This tactic aligns seamlessly with options that see less frequent trading, particularly in markets like the UK.

But for strategies where you’re often buying and selling options, it’s crucial to have good trading volume and open interest.

This makes sure traders can easily get in and out of their trades, without getting bad prices because of big differences between what buyers want to pay and sellers want to get.

open interest vs volume in option trading

Options Markets: US vs UK

Deciding between trading options in the US or the UK involves considering a few key factors.

In the US, the market is larger and offers a wider range of options, including stocks, brokers, and platforms, with a wealth of information available. This leads to more activity and a broader selection of options to trade.

Comparatively, the UK market is smaller, with around 1,000 stocks available for options trading. Due to lower trading volume, executing options trades in the UK may be slightly more challenging. This can result in wider bid-ask spreads.

While the US market tends to set the global tone, it’s important to note that the UK market has its own unique dynamics influenced by local factors.

To add a final footnote on the UK options market. It isn’t all bad. It feels a bit ham-fisted at times. But if you want to trade options on UK stocks (which I have and still do), you just need to pick a strategy that matches what the UK market is like.

In my current approach, I predominantly center on options trading in US stocks and allocate approximately 5% of my total portfolio to UK equities.

Tailoring Strategies to Market Conditions

In options trading, adaptability is crucial. Tailoring strategies to fit market conditions is essential, whether in the US or the UK.

For those employing a hands-off monthly vs weekly options strategy with minimal early position buybacks, the UK’s lower liquidity provides a comfortable environment.

However, traders pursuing a more active approach, involving frequent buying and selling of options, benefit from markets with higher liquidity. This ensures smoother executions, tighter bid-ask spreads, and more favorable trade outcomes.

Conclusion

In the world of options trading, it’s really important to understand Open Interest and Volume. These numbers don’t just tell you how easy it is to trade options, they also help you decide how to trade.

Whether you’re taking your time or trading quickly, knowing how these numbers work together can make a big difference in how well you do as a trader.

When it comes down to it, picking between US and UK markets is about matching your trading plan with what the market is like.

By keeping yourself informed, changing your approach when needed, and using what Open Interest and Volume tell you, you can confidently navigate the challenges of options trading and do a great job.

Happy investing!

READ ALSO: Can You Trade the Options Wheel Strategy with a Small Account Size?

Kevin S

Kevin S

Greetings, I'm Kevin! I am now a full time options trader and investor. I am thrilled to have the opportunity to share my knowledge and expertise with you. My objective is to assist you in navigating the complexities of option trading, regardless of whether you're a beginner or an experienced trader looking to enhance your skills. I'm excited to accompany you on your journey to mastering the art of option trading. Let's make this year an extraordinary one for you!

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Kevin S

Kevin S

Greetings, I'm Kevin! I am now a full time options trader and investor. I am thrilled to have the opportunity to share my knowledge and expertise with you. My objective is to assist you in navigating the complexities of option trading, regardless of whether you're a beginner or an experienced trader looking to enhance your skills. I'm excited to accompany you on your journey to mastering the art of option trading. Let's make this year an extraordinary one for you!

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Welcome to Dividend On Fire, we are a site dedicated to options trading! We specialize in helping investors generate passive weekly or monthly income through selling cash secured puts and covered calls.

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