"Open Interest" in Forex Trading - Application Strategies
Hello, fellow traders!
As you know, the exchange rate of currency pairs is determined by supply and demand, reflected in pending orders located in the so-called “glass”, and in past transactions on the market, expressed in trading volume. The value of this parameter, together with the price behavior, is used to predict future movement - this analysis method is called VSA (Volume Spread Analysis).
Unfortunately, the specifics of the Forex market does not allow you to find out the actual amount spent on buying / selling funds - the volume indicator only reflects the number of transactions. Therefore, traders often resort to volume analysis using the open interest of futures and options. What is this tool, where to look at the data, as well as specific application strategies - in our material.
Futures and standard (vanilla) options (not to be confused with binary options) are derivative assets or derivatives. In the classical interpretation, these are contracts that give the right to supply the underlying asset at a predetermined price after a certain period of time, providing for a partial (collateral) payment of the value of the volume.
Futures owe their appearance to sellers and buyers of agricultural products. In the middle of the XIX century, transactions for the future harvest were thus concluded, allowing manufacturers to fix the cost of goods in advance.
It was also beneficial for the buyer to purchase futures, at the end of the term he would receive either a crop or a refund calculated at the current exchange rate at the time of calculation. Given that the supply disruption could only be associated with a crop failure, at which the price of agricultural products increased, the producer had to compensate for the difference that had arisen from his own pocket.
In the 1970s, futures were standardized by the amount of the underlying asset, called the lot, the amount of collateral - guarantee collateral, the size of the margin, the price step, the duration of the contract - the time of expiration.
Also, in addition to supply derivatives, settlement contracts appeared, where, with the help of clearing, the financial result was recalculated with the removal of negative or accrual of positive margin in the account of the Seller or the Buyer.
Futures Open Interest Concept
Futures is a standardized contract that is valid for a week, month, quarter or year. This period is called expiration time.
The number of futures is theoretically infinite - the exchange acts as the second party and writes out the contract if the trader wants to buy / sell futures and does not find the Seller or the Buyer on it. The site also keeps track of the turnover of derivatives, called by clearingby checking the margin collateral with the holder of the derivative instrument to prevent default during the final settlements that take place on the last day of the term of the futures or option.
The written contract remains open until the trader closes it, having completed “Offset transaction” - by purchasing an equal number of derivatives sold or by selling an equal number of contracts previously purchased (the total is zero).
Any exchange is obliged to report on changes in open contracts, which are called "interest", And their volumes. Information about them is available to online traders (trading feed) and is publicly duplicated on the stock exchange (one or more times) during the day.
Open Interest (OI) of futures is the aggregate volume of purchased or sold, held by traders, derivative contracts.
As can be seen from the presented definitions, in contrast to the trading volume on exchanges and the Forex market, which states the fact of exchanging money and an asset, OI characterizes the level of held or closed positions, most accurately reflecting the demand in the analyzed instrument.
Standard (Vanilla) Options
An option is a more complex financial derivative, sometimes perceived as a second derivative, since it is always based on futures rather than real goods.
In a simple sense, the purchase of an option contract gives the trader the opportunity to insure the asset against a fall or growth above / below a specific price. The value of the asset or the value of the currency pair is divided into strikes - round numbers in increments of 50 points. For each of them you can:
- Buy a Put contract that implies profit from a fall below the selected level equal to the futures one if the contract were sold at a strike price;
- Buy a Call contract and profit from growth above the selected level equal to the futures one if the contract was bought at the strike price.
Insurance is valid for the expiration period - a month, a quarter, which coincides with the terms of futures, but occurs a day or two later. The shift is justified by accruing a new series of deliverable option futures.
Like any insurance buyer, the trader risks losing only the value of the premium paid on the strike, but reserves the opportunity to profit from rising / falling. The seller immediately makes a profit from the transaction, since he is credited with the premium paid by the Buyer, but risks fixing an unlimited loss at the time of expiration.
In reality, 80% of the premium paid goes to Sellers, and the remaining 20% is offset by complex strategies. Options is the only asset whose financial result and the size of the premium of each strike can be calculated in advance. The economists Fisher Black and Myron Scholes, who discovered the strike cost calculation model, received the Nobel Prize for this, and Long-Term Capital Management showed how you can earn brilliantly and lose fantastically.
Another example of high earnings on option contracts was the strategy of a team of students - creators of the Panda robot, who publicly presented the algorithm in the contest “Best Private Investor”. The robot beat market makers, increasing the liquidity of the derivatives market by hundreds of times and receiving a yield of 8000% for three months of trading.
High profit was ensured by the “smile of volatility” - a constructed curve of the change in the theoretical value of Put and Call option premiums, which allowed buying and selling contracts with deviations from its values.
Unlike the spot or futures market, options, as it should be the second derivative, have a non-linear change in the premium on each contract, which depends on:
- From time to the end of expiration and tends to zero;
- The rate of approach to the strike;
Open Interest Options
Unlike futures, in which Open Interest is determined by one value, option contracts have separately considered OIs for Put and Call, posted on each strike.
Open Interest in options is the total volume of Call and Put contracts bought and sold, separated by price level (strike), separately for each type.
As can be seen from the presented definitions, in contrast to the trading volume on exchanges and the Forex market, which states the fact of exchanging money and an asset, OI characterizes the level of held or closed positions, most accurately reflecting the demand in the analyzed instrument. Moreover, option contracts show the interest of bidders for each price level - strike, which allows us to predict the direction of the trend and specify the moment of the price reversal.
Forex Currency Pairs Futures
Currency pair futures are present on many national exchanges, but the Chicago Mercantile Exchange (CME) is considered the international center for trading these assets. This group includes several trading platforms operating on the same platform Designated contract market (DCM). Its section of currency derivatives has a dominant share in global turnover and the number of transactions in these instruments.
As elsewhere, derivatives at this site are standardized in terms of contract duration, called "Series" - week, month and quarter.
Since derivatives are an agreement on the future price of an asset (in this case, currency), they are traded long before the beginning of circulation, for example, futures for the next quarter or month can be bought “today”. At the same time, the quotes of derivatives of the current and subsequent series are approximately the same, therefore, in order not to be confused, each contract is indicated by the international standard digital and letter code.
CME Futures Open Interest Reports
The main page of the CME GROUP website contains summary tables of all assets, broken down by groups of goods, energy resources, financial rates and bonds, indices, and currency pairs (they are designated as FX). To get there, scroll down the site page.
Direct data on the Futures Open Interest will become available when you click on the link under the FX symbol - a new page will open for the trader, where the Open Interest option will be indicated on the side panel.
By clicking on it, the trader enters the “data hub”, uniting the Open Interest of FX futures and options.
To get directly to the OI futures page, click on the leftmost window and on the new page enter the OI Futures option:
The picture will display a CME report on the Open Interest of EURUSD futures currently traded throughout the year. In the four-digit changing code, 6E denotes the name of the currency (6E-EURUSD, 6G - pound, etc.). It is followed by the letter of the month, and the last digit 9 or 0 indicates the year.
As you can see from the histogram denoting Open Interest, the biggest demand is for the current December contract, which begins to be traded in November, in the remaining series there is a slight presence of OI.
The histogram can be changed to a tabular view, which shows the next series (for a month and a quarter). As can be seen from the OI data, the rates of traders are valid only until the 1st quarter of 2020, then zeros are placed.
The table contains a comprehensive data set:
1. Futures code;
2. The remainder of the time before expiration and the number of days in the last month of circulation;
3. The date of expiration - the last day of the contract;
4. closing price;
5. Price at the opening of the market;
6. Change in the course per session (delta in points);
7. Open number of contracts at the end of the day;
8. The open number of contracts at the beginning of the day;
9. Change in Open Interest per session;
The last three columns of OI digits are the direct data used to forecast the movement of currency pairs on Forex.
Reports on the open interest of currency options on the SME exchange
Standard or “vanilla” options on the CME exchange coincide with labeling futures in terms of the month and year designation. Currency options are deliverable, that is, at the expiration of the term, the trader receives futures on currency pairs, which are the underlying asset. Otherwise, they vary greatly:
- By expiration dates - there are contracts on the exchange for a week, a month, a quarter;
- Underlying asset option - currency futures, indicated by two letters, not a number and a letter;
- Open interest in contracts is indicated at each price level and is divided into two types Call and Put;
- Open interest is divided into options in money (ITM and ATM) and out of money (OTM, The differences between ATM and ITM are described below).
The latter designations determine the current probability of receiving an “insurance” premium by the option buyer.
The ideology of the option contract is that, unlike the futures, the trader can hedge future losses of his asset at a specific price level, regardless of its current value.
For example, buying the EURUSD currency pair at 1.10, you can always buy the option “against falling” Put, which will cover the size of its premium all the loss if it happens that the dollar will cost one to one or even less with the euro.
In this case, with a course of 1.10, such a contract will be in ATM status, which determines the equality of the strike to the current exchange rate of a currency pair.
Falling below will give him status ITM, and the trader will receive the right to receive a premium on the Put option (in this example). If at the time of expiration the EURUSD rate does not exceed 1.10, the trader will receive a premium on the account and open short at the current price of the 6E series of the next month's futures.
Call is acquired as insurance against growth: for example, having bought it from the level of 1.145, a trader can safely shorten without worrying about a possible further price increase. Vanilla options are often called “smart stop” - the premium will cover the loss received above the strike level minus the cost of the contract.
It is often called the "intrinsic value" or simply "the option premium" - this is the cost of insurance that the Buyer pays and the Seller receives.
As with futures, both the exchange and the trader can act as the second side of the purchase / sale transaction, therefore the “Open Interest” on each strike, increasing with each new contract issued, is theoretically infinite and remains unchanged until the Seller or Buyer close the contract Offset.
To access the data, the User performs the same actions as in the case of futures: opens the CME exchange website, finds the FX table and, having moved to a new page, clicks on the left side option Open Interest. Three windows will open for him:
The reports required for forecasting and analyzing future movements of Forex currency pairs are in the two extreme tables.
Information on the Open Interest of Options is published on the CME exchange twice a day - in the morning at 8-00 Moscow time in the preliminary report for the previous day, and by its opening at 17-00 Moscow time in the final report.
A trader can observe the changes in the OI in the form of a histogram, in the left corner of which you can select (1) the currency pair of interest, the month of expiration of interest (2) - the nearest (displayed by default) or long-distance (3), see weekly options (4), with a term of expiration on Friday (weeklies) or Wednesday (Wednesdays).
The table can be filtered by the number and type of displayed parameters in the “Settings” settings (5) or see the OI on the previous days (depth - week) through the list that appears from the window (6), the type of the published report is indicated there: preliminary or final.
In the upper left corner of the table you can update the report or download it in PDF format:
A direct analysis of Open Interest to predict the future movement of currency pairs is conducted according to:
1. The total OI CALL and PUT, divided by the left and right tables indicating the percentage of ITM and OTM options;
2. Put / Call Ratio indicator showing the ratio of “traded” daily volumes of two types of contracts;
3. The maximum values of OI Call and Put;
4. Strike and current price level;
5. Changes in total volumes for all series of options for the selected type of instrument;
Forecasting the future movement of Forex currency pairs using options is inextricably linked with the numerical value of the premium, which is located in the table (Option Board), where current and future contracts are combined with futures, which also display a common OI.
The table contains columns of strikes, in each row of which the Call and Put premium is displayed separately, and the green color of the cells indicates the size of the Open Interest value at this price level relative to other cells.
Why is there a reversal of quotes of currency pairs from option levels?
Options levels are considered by Forex traders as lines of resistance and support, therefore they are used in the counter-trend trading strategy for currency pairs. This ideology arose because of the nature of contracts.
The buyer of a “naked” option who does not have a position in the underlying asset makes a profit:
- From an increase in the Call premium as the rate rises and moves away from the strike on which the option was bought;
- From an increase in the Put premium as the rate drops below the strike price of the contract;
In the event of an erroneous forecast, the Buyer will lose only the premium paid for the option. In contrast, the Option Seller risks a limitless loss, and the profit in the form of a premium paid by the Buyer will remain with him only in the event of a “burn-out” of the “out of money” option, i.e. the course at the time of expiration should be:
- Above Put level of sold option;
- Below is the Call strike on which the contract is sold.
Therefore, the trader, in most cases, at the time the contracts expire, will observe the picture of the maximum maximum Open Interest Put and Call from the current values of quotes. Sellers will not, without special reason, write out a large number of contracts at the prices of the first day of trading. The maximum OI will be approximately “on the edges” of the volatility of the week, month or quarter.
Traders who bought Put and Call options are much lower and higher than the current exchange rate of the currency pair (and, judging by the Open Interest, the majority), purchased them at a low cost, which will increase many times when and if the strike equals the price.
But even if this condition is met, there may not be any profit: over time, the option premium tends to zero as the expiration date approaches. Therefore, as soon as the currency pair approaches the strike, profit fixation begins.
It differs from the foreign exchange and exchange markets, since you cannot put a take profit on an option, because the pricing of a contract premium depends on many parameters described by the complex Black-Scholes formula. You can fix a premium instantly by selling an equal number of futures against the Call option or by purchasing against Put contracts.
The higher the open interest of the strike, the more futures will be sold or bought against the fall or growth of the currency pair. In theory, as the price increases or decreases, one can expect a gross increase in counter-trend transactions equal in volume of OI crossed by the strike quotes.
Thus, the size of the Open Interest determines the probability of a trend reversal and the strength of the level:
- Resistance - by the number of open Call contracts;
- Support - on the open interest of Put contracts.
The material provides a simple example of the work of the mechanism that causes the reversal; in practice, option strategies are a complex structure of bought and sold contracts of various types related to foreign exchange spot and futures. In any case, the price movement causes a reorganization of the so-called exposure, which can lead to a reversal of quotes.
To find pivot points, traders use options for a month and a week (Friday). The former give the most significant levels of quotes rollback, the latter guarantee this movement with less probability.
Counter-trend trading strategy for currency pairs by the levels of maximum OI of currency options
To find pivot points, traders use options for a month and a week (Friday). The former give the most significant levels of quotes rollback, the latter guarantee this movement with less probability.
Many strategies on the Internet are advised to use each level, confirming the reversal through the formation of pin-bars or technical indicators, in particular, oscillators. We will consider a strategy based entirely on Open Interest analysis.
Currency pairs: major, except for USDJPY and USDCAD
Trading time: around the clock
Recommended brokers: Alpari, RoboForex, Exness
The algorithm of work and analysis of the movement of currency pairs at the levels of OI options CME
- On the SME website at 7-45 Moscow time (8-00), we tear off the visual histogram of OI options for the next month, which appears in the preliminary report (Prelim);
- We determine the levels of maximum OI Call (resistance) and Put (support);
- We turn to the table “Options Board”, where we find the cost of the premium for the levels of maximum OI Call and Put;
- We add the found values to the resistance Call, subtract the size of the bonus in points from Put support and put the levels on the chart;
- Based on the calculated numerical values, we set Buy limit (Put minus the premium of the strike max. OI) and Sell Limit (Call plus the premium of the strike max. OI) or enter the market if the current rate has exceeded the found values;
- At 18-00 Moscow time (19-00), we check the strike positions of the maximum OI Call (resistance) Put (support) in the final report, in case of a change in position, close the existing orders with a profit, (set second-hand) or recalculate pending (Buy / Sell Limit) applications;
- In case of order activation, set the take profit by the level of the Minimum Payout Points (by the level of the strike highlighted on the Max Pain histogram), stop loss by 150-250 pp;
- The algorithm for determining levels for weekly options is similar, but a series for the next month has a higher priority and probability of profit.
Setting and algorithm for calculating optional levels
Open the CME’s Open Interest Profile page and select the middle OI & Settle Detail window.
Select the analyzed currency pair in the “Select Product” option drop-down list. By default, EURUSD will be selected for the next month of expiration, the date of which and the number of remaining days can be found in the window to the right of the instrument selection option.
Define the strikes of the maximum Call and Put OI as resistance and support levels:
In this case, it will be 1.12 and 1.16, but the levels will need to be adjusted for the size of the option premium, which is known from the table values available in the Option Prices option.
- For the Put option, the premium is 15 pp;
- For Call option - 24 pp.
Thus, the actual location of the levels will be at 1.1215 and 1.1624. The bonus changes daily, so the levels are dynamic.
We perform similar actions with weekly options, which are selected from the Weeklies section. We select the next week from the drop-down list and put optional lines on the chart, you can make them smaller in thickness to distinguish them from the levels of the month.
In the example shown, the levels will be equal: Put 1.1300 and Call 1.1450.
After applying them to the chart, adjust the lines according to the option premium table available through the Option Prices option, adding 39 points to Call + and taking 7 points away from Put.
Features of reports on options on “reverse” currency pairs
The CME exchange publishes quotes only in the format of “direct pairs”, that is, USD is always in the denominator. Therefore, when analyzing the USDCHF (the other return pairs are excluded from the strategy), the trader must independently calculate the strikes (divide the unit by the “table value”) and mirror the signals:
- Falling below the Put level is a sell signal;
- Growth above Call - purchase;
The figure shows a visualization of the optional levels of USDCHF, where the strike level of the maximum Open Interest for Call and Put is the level of 1.055, showing a strong fall in the rate below these values. This means that the rate has risen above 1 / 1.055 = 0.95 and you should look for a point of sale. The option premiums in the strike table are indicated in points, therefore, do not need to be recalculated, the levels are adjusted by adding and adding their values to the division result, in this case 0.95.
Rules for buying and selling a currency pair according to the counter-trend strategy for analyzing option levels
The strategy uses only the maximum interest levels of the option for the current month and week. Each morning after the release of the report, in the region of 8-00, the trader applies and adjusts, according to the premium, the maximum interest levels of Call and Put for each currency pair.
A limit order is set for the received values:
- Sell limit on Call option with maximum Open Interest;
- Buy limit on Put option with maximum Open Interest.
The report must be re-checked at the first hour of the beginning of the American session for changes in the position of option levels compared to the previous report. Any rearrangement is a signal to exit a position: on the first day at the entry price or with profit taking, on the second with a current loss.
Stop Loss and Take Profit
It is advisable to use a high level of stop loss - from 3 to 5 strikes. Options on the main currency pairs have a standard step between strikes equal to 50 points, as can be seen from the tables, so the optimal stop should be 150-300 points.
If quotes crossed the resistance / support level for the first time, it is advisable to set a loss limit for the second session after the order is triggered, or actively use a grid strategy, the second knee of which is placed at the “central strike” price level (the option premium is at the price level highlighted in the report CME).
Ideally, the grid should end with the maximum premium of the central strike on the first trading day of a new series of options, and the position should be held until the last day of expiration.
Take profit should be set to the strike level of Max Pain - it is considered that this is the Minimum Payout Point (TMB) or the minimum total loss of the Sellers and Buyers. The currency pair will always strive for this point of "relative equilibrium." To find out its value, click on the option “Max Pain” in the left panel, the TMV strike will be highlighted in a separate frame.
It must be remembered that no one guarantees that the course will necessarily reach the values of the Minimum Payout Point!
Important features used in trading currency pairs at option levels
- Entrance to weekly options should be carried out before Wednesday, - on Thursday pending orders are canceled.
This tactic is associated with a sharp outflow of liquidity in options that start on Wednesdays.
- Rolling - moving Maximum Interest levels in 80% of cases predicts a strong movement or a trend change - Call or Put to the right, predict a course increase, Call or Put to the left - fall.
Option sellers maximize profits by selling options closer to the current price, or minimize losses by writing contracts as far as possible from the course, having an insider that allows you to predict in advance the direction of price changes in the future. As described above - the risk of the Seller is "infinite", so this work requires accurate forecasts.
The error of this method of analysis is due to the fact that it is possible to confuse the rolling signal with a simple movement of the OI due to the depreciation of the premium - the temporary decay constantly affects it and the position. Therefore, traders can simply step out of worthless options.
- Swapping the levels with the maximum open interest Put and Call is a signal to prohibit the opening of a transaction.
Traditionally, Option Sellers offer Call above the current price level, and Put is much lower, which increases the likelihood of an OTM contract outcome - out of money. If the levels are reversed, a complex combination of option strategies works on the market, this will lead, in most cases, to a strong increase or fall with no reversal.
- The importance of continuous analysis (from day one) of a new series of options.
The options premium changes daily due to a temporary breakdown, but, as practical experience on the maximum levels of OI shows, the first point of intersection of quotes and the found level is important. An attempt to enter the short “lower” or the long “higher” on the basis of analysis, without taking into account the previous reversal, can lead to loss.
Since the strategy is counter-trending, the exchange rate may return to the reached maximum values or the resulting signal of level rolling will force the trader to leave the position at a loss.
Examples of transactions in currency pairs, based on the analysis of option levels
A strong drop in EURUSD led to quotes ending Tuesday's session “on the floor”, which affected the “departure” of the rate for the Put level of the weekly WEDNESDAY option (expiration on Wednesdays) located at 1.1400.
According to the level calculations, the option premium on this strike was 73 pp, which means that at the time of the first day of the action, the current rate was lower than the calculated level for entry 1.1327 at 1.1288, so the long was taken on the market.
After entering the market, a stop loss was set for three strikes at the level of 1.1150 and a take profit determined from the Max Pain histogram at 1.14, where the previously taken long was closed with a profit of 100 points.
The expediency of buying a weekly option on EURUSD is explained by the fact that at the beginning of the December series of contracts for a month, the drop was “not enough” to trigger a pending buy order.
According to the maximum Open Interest levels, Put was located at around 1.12.
Even without calculating the level of premium, due to the change of which it would be necessary to lower the support line even lower, it is clear that the reversal occurred before 1.12.
The situation was different in the December series of monthly options: the USDCHF CALL levels on the first day of trading turned out to be significantly higher in the CME chart of the current price, which meant a short signal due to the need for their mirror conversion. After dividing the unit by strike, we got a resistance value of 0.955.
The options of the month have a very high premium at the start of trading, the table indicated a correction of the received line to plus 550 points, i.e. to the value 1.0, where a pending short order was placed, which worked on the second day after the start of trading on the option.
At the moment, the transaction makes a profit of 150 points, and the level of Max Pain is quite far, so it makes sense to establish a breakeven.
In the December options of the AUDUSD currency pair, the maximum Open Interest Call level was rolling. As a result of the change of position by market makers selling options, the bar of the histogram has moved to the left, which is perceived as a signal of a future fall. According to Friday's reports, the maximum OI took strike 0.75, but on Tuesday moved to the level of 0.7250.
Rolling coincided with a fall in the exchange rate, but it is in this example that I want to pay attention once again to the word “coincided”, because the real reason for the shift in the maximum OI was a temporary decay, which led to a decrease in the cost of the premium to 5 points.
In this case, the bias is perceived as an indirect signal, but the fact that market makers left max without moving. OI Put, indicated a possible continuation of the correction.
Observing the expiration of currency futures, as well as other instruments, one can notice one constancy - about 80% of the options purchased end with a burnt premium. The buyer, who receives insurance, thinks that he is protected from losses, but the premium and option level are calculated by the Sellers so that he could not earn.
Therefore, the maximum option levels make it possible to forecast, accurate by 80%, and about the same trading performance, if you do not forget about the features of their analysis. Only a part of the examples is given in the material - option transactions are analyzed even by scalpers (in the constant flow of levels) and intraday traders, using Open Interest changes of the nearest levels, analyzing the Put / Call Ratio and the balance of “position reset” during breakdowns of strikes by the current price.
Such analytics require direct access to the CME exchange or the presence of paid subscriptions for additional software, we will consider these tactics in the following materials.