Volume change in options
Why Open Interest and Trading Volume Matter to Options Traders
In short, option volume is the number of contracts traded in a security or an entire market during a specific time frame, usually one trading day. It is simply the amount of options that change hands from sellers to buyers as a measure of activity.
If a buyer purchases contracts from a seller or a market maker, then the volume for that period increases by contracts based on that transaction. Let's look at another example. XYZ at the October 30 strike.
Open Interest vs. Volume: Understanding the Difference
On the same day, Bill buys calls for the same strike and month. This result would hold true regardless of whether the XYZ calls were bought or sold by either Jim or Bill. As you can see, option volume indicates the number of contracts traded at a particular strike for a particular option for a specified time frame.
Option volume is a useful tool for traders, as it can point out where traders are focusing their attention on an intraday basis.
For instance, assume that XYZ Inc. High call option volume could be the result of such an occurrence, as options traders try to take advantage of the underlying stock's move higher.
Vice versa, a volume change in options reaction to the same report could bring about a spike in put option volume. However, if you did not know that XYZ Inc. As such, option volume can be an handy indicator for events known or unknown surrounding a particular stock.
Option volume and stock price behavior: Some evidence from the Chicago board options exchange
Where open interest indicates the actual number of puts or calls in residence at a particular strike or for a particular period of options, volume is merely the number of contracts changing hands. Just because option volume spikes at a particular strike, does not mean that open interest will increase or decrease.
For example, let's return to the calls that were traded on XYZ Inc. Let's say that this particular strike already has open interest of contracts.
Without knowing whether or not this option volume was bought to open or sold to close, we do not know if open interest at XYZ's October 30 strike will increase or decrease, or if it will change at all.
If the calls were bought to open, then we could see open interest increase to contracts. Meanwhile, if these calls were sold to close, then we could see open interest decline to zero. Furthermore, if these contracts were merely changing ownership, we could see no change in open interest at all. To arrive at this figure, the put volume is divided by call volume.
Such volume change in options are calculated on individual stocks, indices, or the overall market. Looking at our example on XYZ Inc.
The closer this ratio moves to 1. Such a development can be seen as a contrarian indicator of excessive pessimism, and can hint at a potential bottom, or rebound, in the underlying stock or index.
The inverse can also be seen as a contrarian indicator for a potential top, or roll over, in the underlying stock or index.