In options trading, two of the most commonly used metrics when analysing the market are open interest and trading volume. These serve as essential technical indicators to help a trader gauge the sentiment of the market regarding the options or futures contract trade.

Here is an explanation of these two metrics:

Open Interest: Open interest refers to the number of options contracts and futures contracts that are active for an asset at a specified  time. It is a mark of the positions of securities in the market that are not yet closed. It is used as a measure of liquidity alongside market activity. Like any other security traded in the market, open interest is subject to volatile market fluctuations.

Open Interest increases when new contracts are created or opened. The increased number of open interests would mean that there are more buyers and sellers for a particular security. Conversely, open interest decreases when positions in the existing contracts are closed out. A lower open interest indicates a disinterest by traders in opening new positions.

Trading Volume: The volume metric documents the number of options or futures contracts that are exchanged between buyers and sellers on a specified trading day. It further quantifies the level of activity for a specific contract.

Every transaction is factored in for the computation of the daily volume. Trading volume is one of the best measures for gauging the market activity for a particular security and shows directly its market liquidity value. When the trading volume is higher, it reflects that other traders are actively interested in a particular asset. In addition, if the trading volume is higher along with a price change, this indicates that there is a favourable opportunity to invest as the volume metric establishes a direction, which helps traders to make trade decisions.

Open Interest vs Volume

These metrics are both useful but in different ways. They are both indicators of liquidity and market activities. Open interest tells you how many contracts are active for an asset at a given time. Volume is more specific: it tells you how many contracts were traded in a specific period.

Open interest is highly volatile, subject to dynamic increases and decreases. It gives the overall picture of active interest in a particular security. This metric is not frequently updated.

Whereas, volume measures the trade for a specific period and specific security. The total volume is calculated and maintained by the securities exchange at the end of each day.

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Remember, options trading involves risks, including the potential loss of your invested capital. It’s crucial to conduct thorough research, seek professional advice if needed, and start with small, manageable positions as you gain experience and confidence in trading options.