Open Interest-The big O of F&O

Option writing refers to selling of the option contract, writers are the one who bring options into existence by selling them. Just like Insurance contracts come into existence by Insurance companies selling them.

The Market views differ but unlike Option Buyers Not only one of the two (Up or Down) directions, But also No move helps option writer.

While Call Buyers' Bias = Bullish

Call Writers' Bias = Neutral to Bearish

Similarly,

While Put Buyers' Bias = Bearish

Put Writers' Bias = Neutral to Bullish

This brings us to an interesting inference

Call Writers' Expectation = Stock/Index =< Strike Price or Stock/ Index Rise could be Capped at Strike Price

Put Writers' Expectation = Stock/Index => Strike Price or Stock/ Index Fall could be Floored at Strike Price

On the other hand, Call Undwinding / Put Unwinding could also be seen as lowering Writers' Interest a.k.a. confidence in aforementioned Capped or Floored Strike Price

Call Unwinding (especially where OI is highest) = Expectation of Higher Cap or More room to Rise

Put Unwinding (especially where OI is highest) = Expectation of even lower Floor or More room for Fall

This can be conveniently observed in the OPEN INTEREST tool of Quantsapp, where the red bars indicate open interest of Nifty put options and green bars indicate the open interest of Nifty call options, as indicated in the template ahead.

Similarly, the open interest study can be carried out for different F&O stocks in India and also listed equity indices, all through Quantsapp.

For every open interest, there is a buyer and there is a seller of the financial instrument under consideration; in our case, NSE F&O options.

But the open interest data is studied from option writers’ perspective, because they are the traders/participants with deep pockets, as writing entails assuming theoretically unlimited risk and limited reward (restricted to option premium). Also, it requires the participant to put up initial margin with the exchanges. With lot at stake, there is a perspective in the market, that these option writers or option sellers may have a better inkling/hint as to where the underlying is headed.

For example, in the insurance business, the insurance company undertakes underwriting of policies and determines the terms of conditions of the insurance policy based on their guesstimates of probable returns to risks inherent in the particular transaction for which the policy has been underwritten. While, consumers are large in numbers but the transaction tends to be skewed in favour of the insurance company, rather than the insurance purchaser (consumer). This is similar to the case of option writer or option seller and option buyer.

Takeaway: Risk Takers make Business of Risk Possible