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Futures and options are contracts and similar to any other contract it is a contract between a buyer and a seller. Buyer is bullish expecting the market to go up and seller is bearish expecting it to go down. Only when there is trade between a buyer and seller, a contract opens and all such open contracts are together called as open interest. So if I have bought 1 lot of Nifty expecting it to go up and you have sold 1 lot expecting it to go down, that makes it 1 open contract and hence the open interest of 1.
Typically every derivative contract will have its own OI, Nifty August futures will have its own OI and September futures will have its own. Similarly, OI will be different for calls and puts of various strikes. OI will go up when more people start participating or existing people start adding positions. According to the OI theory, typically when a market is going in a particular direction and there is a huge addition in OI, this means there is more conviction in the move.
So if the market is falling and there is a huge addition in OI, this would mean that the existing short positions which are making profits are adding more and hence the fall could be bigger. But understand that this is only theory and may or may not work like this in reality.
While trading options, the money required to buy options is much lesser than what is required to write sell first. So typically the people who write options are people having access to higher capital and hence the logic is that they are more proficient traders.
I guess it is important to also understand why retail traders typically buy options and institutions sell them? Retail traders are always looking at buying options because technically you have chances of making unlimited profits with investments of small premiums, very similar to how lottery tickets work.
What a retail trader forgets to look at is the fact that the odds of winning are much lower than when you are writing options. Assume that Nifty is at and A buys the call at Rs. Since A is buying Rs. A can make unlimited profits from his Rs , but B can make a maximum of Rs from the Rs invested. But check out the odds and see which side you want to be on. For B to win at Expiry: Nifty stays where it is, Nifty goes below and Nifty goes up but stays below , he can make profits in 3 different scenarios compared to an option buyer who can in only 1 scenario.
As you will see the odds of a writer winning are higher. But also understand that as a writer of options you take unlimited risks and being lax on risk management would mean a severe dent to your trading account. Coming back to the query, when OI for calls is going up, there are new buyers and sellers writers coming in and since the writer is a more proficient trader as explained above, the belief is that he is probably right and better be on his side of the trade which is basically expecting Nifty to not cross So if someone says OI on Nifty calls has gone up significantly, according to the OI logic it means that if Nifty is above it might come below and if it is already below , it might find it tough to go above If I sell 2 lots and there are 2 people X and Y who have bought 1 lot each, assuming we are the only people trading the contract, the OI is 2.
What happens if X who has bought 1 lot sells it to another person Z, what is the OI now? When X sold the lot he had bought from you to Z, a new contract was not created; the existing contract just changed hands so the OI will remain two.
But if Z bought say 1 lot from anyone other than X and Y, then that would be a new lot and hence the OI will now go to 3. Since in the query above a new lot was not created, the OI remains at 2. If the market is going down and OI is increasing market could go even lower because of the OI logic.
Assume the OI is presently 10 on Nifty futures and Nifty is at This means there are 10 lots long and 10 lots short. At , OI went up to 20, basically doubled.
When OI went up, either the people who were holding positions from before added or new people came in and bought and sold lots. If you were looking at all of this, which side would you want to be on, long or short? Understand that at , longs are sitting at 50, loss and are weak and shorts are sitting on 50, profits and are stronger. That is why we infer that if OI went up significantly when market goes in a particular direction, the direction might continue for much longer.
Logic behind assuming that if the OI for calls went up significantly, markets might not cross ? Let me give you an example, assume you are sitting in an exam on financial markets and there are 2 people sitting next to you. One is Nithin who has almost 15 years of experience in the domain and on the other side is this boy called Siva who is just 2 years into the business and still confused about what the business is all about. If you had to copy, from whom will you copy, Nithin or Siva?
So if you had to bet, be on the same side as the proficient one because the odds of winning go up. So when the OI for calls is going up, there are new buyers and sellers coming in and since sellers are more proficient traders we assume that they are right and hence the market may not go above This is all a theory and may or may not work in real life, but we at Zerodha proprietary trading desk believe it works and are also planning on a tool to help all our traders to track the OI to know what direction the professional traders are in.
According to this theory the underlying Nifty in the above example on the expiry day will gravitate towards that point at which option buyers will feel the maximum pain, basically a point where the maximum number of options, both calls and puts value could become zero worthless on the expiry day.
To calculate this we need the open interest of both calls and puts for various strike prices Nifty in this example and use a correct formula to calculate the MaxPain point. Once you have a formula to calculate MaxPain there are 3 ways in which you can use it for trading, assume Nifty is presently and MaxPain is showing You can setup strategies assuming that Nifty will go towards You can use this for position management, which means that if Nifty is below the MaxPain, take larger buy positions than short positions, because we are generally expecting Nifty to go up.
Similarly if Nifty is above the MaxPain, take bigger short positions than long ones as you expect the market to come lower towards the MaxPain. Keep tracking MaxPain and anytime there is a big move, either up or down, use it as a buy or sell signal respectively.
We at Zerodha are looking forward to providing you a tool to track a proprietary strategy of MaxPain for Nifty on our new website. This tool can then be used in any of the 3 ways mentioned above.
If the ratio is more than 1, it means that more puts have traded during the day and if it is less than 1 it means more calls traded during the day. NSE shares this information on this link daily. Assume that this average range for PCR over the last 1 year is in between 0.
Like MaxPain, PCR is also a contrarian strategy which believes that option buyers will typically lose money. So a typical way to analyse PCR would be:. If PCR is below 1, it would mean that more calls are being traded and since more calls are being traded by the retail traders option buyers this could mean that the markets might do the opposite which is go down.
Lower than 1 the PCR is, higher the chances of the market coming down. Since you know that historically PCR has been in the range of 0. If PCR is above 1, it would mean that more puts are being traded and since more puts are being traded by the retail traders option buyers this could mean that markets might do the opposite which is go up.
Higher than 1 the PCR is, higher the chances of the market going up. Since historically PCR is in the range of 0. Love playing poker, basketball, and guitar. Lastly thanks for this write up and hope you will provide many more such articles for mutual benefit we gain and trade more and you get more brokerage. It is tricky to put a formulae to calculate maxpain as there is none. We have to calculate it based on our own logic. We will share the tool that we internally use at Zerodha and should be up with our new website in the next couple of months.
You can use Kite, has over indicators http: Hello Sir, is the tool to identify Max pain available in Zerodha website. If yes where this can be find. Hi, Sir is the formula that you use internally at Zerodha to calculate Maxpainpoint available yet? I have one doubt Sir. What will be the OI change. What you can track is whether the net OI for an individual contract is going up or down. I have checked on the column options available.
If this feature is already available but I am unaware, please advise me. Yes, OI change is currently not available. On our list of things to do. Do read about why it might not be smart to track OI intraday. You can add Open Interest from here. PCR is not available for Nifty Options alone.. It is available for Index Options.. You can get it by clicking here. On Expiry day all contract come to end with cash settlement, but end of the day still open interest show it,how?
What it mean by? If you are checking for the Aug futures open interest after market closing, it will basically be showing the last OI before closing of the contract. But if you are looking at general Nifty Future OI, there will be Sep futures and Oct futures which will be open at the end of Aug futures. Max Pain is a theory and may or may not work the way it is mentioned.
Market moves according to itself, but more often than not tends to go towards the point where it can hurt the options buyers the most. Currently nifty is at It has appreciated by pints in last 3 days. Today data shows nifty index future OI increased by 1. So what I should infer by OI theory? But if a lot of calls are being written, then ideally according to Max pain theory, market will not go up much. Hi, I just noted that for the option contracts data, zerodha does not have greek variables delta, theta etc.
Will we get that data in zerodha?