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When and Why Trading Volume Greater Than Open Interest?

In options and futures trading, volume and open interest are essential indicators of liquidity and market activity. Many traders expect open interest to be consistently greater than trading volume. However, there are rare instances where volume surpasses open interest. This article aims to unravel the mystery behind this occurrence and provide a deeper understanding of the factors influencing these metrics.

Decoding Volume and Open Interest

Trading Volume

Trading volume represents the total number of contracts traded for a specific derivative, such as futures or options contracts, within a given time frame (daily, weekly, or monthly). Both opening and closing transactions contribute to trading volume, showcasing the overall market activity. Trading volume resets to zero at the beginning of the time frame, allowing for a fresh start in measuring market activity.

Open Interest

Open interest denotes the total number of outstanding contracts that have been opened but not yet closed, either through offsetting transactions, exercise, or delivery. It is a cumulative measure of active positions in a derivative market, illustrating the net change in contracts over time. In contrast to trading volume, which resets daily, open interest focuses on the accumulation of unsettled open positions.

Due to this difference, it is normal for open interest to be greater than volume in most cases.

Related Reading: What Does Open Interest Mean in Options?

Scenarios Where Trading Volume Greater Than Open Interest

Active Intraday Trading and High-Frequency Trading

In times of increased intraday trading, opening and closing transactions may see a significant rise. High-frequency trading algorithms can also increase trading volume, as they take advantage of short-term price changes. However, since most of these transactions close on the same day, open interest experiences minimal net change. Consequently, trading volume often surpasses open interest in such scenarios.

Picture a day when the previous day’s open interest is at 4,000 contracts. A crucial economic report is released, sparking a surge in market activity. Investors promptly buy and sell in response to the news, leading to a trading volume of 8,000 contracts. Among these transactions, 4,500 contracts are opened, and 3,500 contracts are closed. By the end of the day, open interest increases by 1,000 (4,500 – 3,500) to reach 5,000 contracts. In this instance, trading volume exceeds open interest.

New Derivative Listings

Open interest will be initially low when a new derivative is listed since market participants haven’t established significant positions. As traders execute both opening and closing transactions, trading volume rises rapidly. However, open interest grows comparatively slower, as it only reflects the accumulation of outstanding contracts. This imbalance between trading volume and open interest can lead to volume exceeding open interest during the early stages of a new derivative listing.

Imagine a new derivative listing with an initial open interest of zero. On the first trading day, market participants open 2,000 contracts and close 500 contracts. In this situation, trading volume totals 2,500 contracts (2,000 opening transactions + 500 closing transactions), while open interest rises to 1,500 contracts (2,000 – 500). In this scenario, trading volume can outpace open interest.

High Closing Position Due to Expiring Derivative Contracts

Envision a scenario where numerous futures contracts are nearing expiration. Market participants will opt to close their positions to avoid delivery, resulting in a surge in closing transactions. This increase in trading volume will coincide with a reduction in open interest as outstanding contracts are settled.

A similar situation can occur with options contracts approaching expiration. Thus, during the final stages of a contract’s life cycle, it is common for trading volume to be higher than open interest.

Consider a situation where the previous day’s open interest is 5,000 futures contracts, set to expire in three days. Anticipating this event, traders decide to close 3,000 contracts or roll them over to a later expiration date, while 1,000 new contracts are opened. As a result, trading volume is 4,000 (3,000 closing transactions + 1,000 opening transactions), while open interest decreases by 2,000 (3,000 – 1,000) to reach 3,000 contracts. In this case, trading volume is also higher than open interest.

Delays in Open Interest Updates

The Options Clearing Corporation (OCC) updates open interest data once per day, usually in the morning following the previous trading session. This delay is due to the complex and time-consuming process of aggregating net changes in outstanding contracts across all market participants.

In contrast, trading volume is updated in real-time, reflecting ongoing market activity and providing traders with a measure of liquidity and market interest. This difference in update frequency can result in temporary situations where trading volume greater than open interest. However, as the OCC updates open interest data, the relationship between the two indicators may revert to its normal pattern.

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