Open Interest (OI) - the number of derivative (futures or options) contracts which haven’t expired or  completed in the market by the end of the day. So open interest shows how big is the long and short positions in the market and how much money are in the market.

Therefore:

• Open interest increases, if two persons “sign” an agreement and buyer opens a long position and seller opens a short position (for the same amounts).
• Open interest dercreases, if two persons “cancel” an agreement (in new market conditions) and buyer closes a long position and seller closes a short position (for the same amounts).

Here of course you must understand that one side in the futures and options markets is exchange.

Open interest vs volume

As I previously said, open interest shows how much money are in the market. But what volume shows us? Not how much money are in the market but how actively this money is used.

The difference here is that open interest do not count money which came in the middle of the day and went away before the end of the day. Open interest count only those money which were left for then ext working day.

For example, three people can 10 times to resell (rebuy) 1 contract to each other 10 times during a day. Volume will be equal to 10 contracts, but open interest to 1 contract.

Open interest – Trading signals

Why should we look at the open interest? Well open interest has a quite interesting feature to move in the same directions as prices (or vise versa, prices after open interest). For example, look at the 3 year history of price and open interest changes in the light sweet crude oil futures market.

Middle term trends in price graph and open interest are the same. Also if you look at the tops and bottoms in shorter term, they often coincide on both graphs. During May 2011 oil price fell by 14%, open interest fell by 8% the percent changes are different but directions are the same.

Such open interest feature allows to make a conclusion: if we see a top (bottom) at the open interest graph we can also wait for a top (bottom) at the price graph.

Of course as any indicator it cannot be used alone and you must take into account expiration dates. Very often open interest falls during the last month before expiration.

You can look for open interest data at CFTC website inside Commitments of Traders reports.