Level 3: Derivatives & Options
1. What is Open Interest (OI)?
Open Interest represents the total number of unsettled active derivative contracts in the exchange. In options, institutions and big money are predominantly option sellers (writers) because selling options provides a statistical win probability of over 68% due to time decay.
Option Chain Rule: Always view the Option Chain from the perspective of the Option Seller:
- High Call OI: Represents Heavy Institutional Resistance (Call Writers capping upside).
- High Put OI: Represents Heavy Institutional Support (Put Writers defending downside).
2. Interpreting the 4 Price-OI Combinations
| Price Action | Open Interest (OI) | Market Signal | Interpretation |
|---|---|---|---|
| Rising (↑) | Rising (↑) | Long Build-Up | Strong aggressive institutional buying. Bullish continuation. |
| Falling (↓) | Rising (↑) | Short Build-Up | Aggressive institutional short sellers entering. Bearish. |
| Rising (↑) | Falling (↓) | Short Covering | Bearish sellers forced to close losing positions; fast rally. |
| Falling (↓) | Falling (↓) | Long Unwinding | Buyers booking profits; temporary market cooling. |
3. PCR (Put-Call Ratio) & How to Use It as a Contrarian Indicator
PCR is calculated as: Total Put OI ÷ Total Call OI
- PCR > 1.30: Extremely Overbought. Market may witness profit booking or short-term reversal.
- PCR < 0.65: Extremely Oversold. High probability of violent short-covering bounce.
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