We had a SlingShot Trader member ask us if traders can use open interest as an indicator of a tradable opportunity. Find our answer below.
I wouldn’t necessarily look at high or low open interest as really predictive of anything other than hedging activity. That’s really what tends to drive option trading activity to unusual levels, when everybody’s really nervous.
Let me give you an example. In the video, I bring up the Financial Select SPDR (NYSEARCA:XLF) and show you the open interest on the XLF May contracts.
[The XLF's top 10 holdings are Wells Fargo (NYSE:WFC), JPMorgan Chase (NYSE:JPM),Bank of America (NSYE:BAC), Citigroup (NYSE:C), U.S. Bancorp (NYSE:USB), Goldman Sachs (NYSE:GS), American Express (NYSE:AXP), American International Group(NYSE:AIG), Simon Property Group (NYSE:SPG) and Berkshire Hathaway.]
Right now, the open interest in the XLF is more even than it’s been for a while, but there is quite a bit of open interest on the put side. They’re probably not speculators buying puts; they’re probably hedging a long position. That’s what tends to spike that figure.
But there are several active contracts, especially the XLF May 19 calls, but you can see that the open interest on the puts and calls in the 19 strike is pretty evenly matched. So, I think it’s hedging that’s driving that open interest higher.
So, is it something that we could us to trade off of? Probably not. If it were, I would look at the volume and say, “Well, 5400 new contracts were opened at that price. We don’t see any activity like that on the call side so, clearly, investors are still hedging.”
I think that what it’s really telling us is pretty stuff we already know, and that is that investors are really nervous about a downturn. They’re probably right; it’s just a matter of waiting it out.
Investor Place advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.