Importance of open interest in trading

A) Finding resistance and support level :

• Max OI in option chain can be considered support and resistance

• You can also analyze change in OI on these levels

B) Finding stock breadth/direction/sentiment(using PCR- put call ratio):
- PCR > 1, puts are dominant so it means bullish view
- PCR < 1, bearish view
- if PCR is high > 1.5(generally), overbought sentiment
- if PCR is too low < 0.4(generally), oversold zone
- PCR decisions could be made based on 1 year percentile basis also.

C) Cumulative future open interest :

• it is summation of OI for current, next and far month expiries. It is outstanding future contracts that have not been closed or settled. It helps in sentiment and potential price movement.

D) Analyzing OI trend :

• There are 4 type of situation

  • Long: rise in OI with rise in price

  • Long cover: fall in OI with fall in price

  • Short: rise in OI with fall in price

  • Short cover: fall in OI with rise in price

• There are 4 more situation if we want to pick aggressive or top situation

  • Aggressive long: rise in cumulative OI + rise in price + increase in volume & delivery from its 5 day avg(you can define time according to yourself)

  • Similarly, Aggressive short, aggressive long cover, aggressive short cover