What is the relationship between volume and open interest [on options]? Is one more important than the other? What is the minimum number one should watch for, before placing an option trade. Should one exit the trade when the number drops below and remains below, the stated minimum number? (January 27, 2001)
Open interests shows the number of contracts that have been opened on a certain option either by selling the option to open a position or buying an option to open a position. Volume as shown on programs such as eSignal is the volume in contracts for that session. Thus over time there are usually more open interests than volume for a particular option. As far as importance, we like to see over 100 open interests in a particular option because that means it is fairly liquid and we have a better success in using pre-set stop losses and stop limits. The less trades made in an option, the less likely a trade will be made at your stop price and thus 'activate' the stop order. If there are less than 100 open interests that does not mean we won't buy or sell the option to open a position, but it does mean we have to realize that we will have to be more diligent in keeping up with it when we want to sell or if it goes against us and we want to cut losses.
We like seeing good volume in an option when we are placing an order to buy or sell as that way we have a better chance of shaving the spread and getting a better trade. It also shows us that there is a lot of interest in the position and that means it will more than likely give us better movement as well.
As far as exiting a trade if open interests fall, we won't unless the trade is not going according to our plan. In other words, just because open interests fall below 100, that does not mean we will exit the trade. If the play is still working for us we will stay in it. We just have to be aware that stop orders will have less likelihood of being executed.
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