Derivatives Session 6

Variables and how to analyze them

Variable No 1

Open Interest
Open interest is the total number of
futures contracts that are open i.e not
closed or delivered on a particular day.
These represent the contracts that have
been bought or sold but not settled.

definition
Day 1 A goes long on one +1 1
futures Contract

Day 2 C goes long on five +5 /-5 6

future contracts and B
goes short by the
same quantity.
Day 3 A goes short by -1 5
offsetting his long
position
Day 4 E opens fresh sell +5/-5
positions and C
offsets the existing
position
Currently Kartik is long on 1000 contracts.
Prakash is long on another 4200
contracts. Sanjay is short on 5200
contracts. The following are the trades
undertaken by them . Show it affects
volume and open interest positions.

Quants
Day 1 Karthik sells 500 contracts& Prakash buys 500
contracts

Day 2 Karthik buys 700 contracts & Prakash sells 700

contracts

Day 3 Karthik buys 200 contracts and Sanjay sells 200

contracts

Day 4 Karthik sells 800 contracts and Sanjay buys 800

contracts
Sr Price Open Interest Signal Implication
No Trend Trend
.
1. Prices are Open interest Bullish More participants
rising rises @ faster Sign are entering the
then its five year market with
average. aggressive buying
2. Prices on O.I numbers Warning
top flatten after rising Sign of an
trend in both impendin
prices and O.I g top
3. Sudden High open Bearish Liquidation of Long
price drop interest in the Sgnal contracts.
after steep market tops Occassionally self
rise feeding downward
spiral
SrN Price Trend O.I Trend Signal Implication
4 Prices Rising Unusually Danger When the trend is
high or reversed expect
record O.I bearish trend to
start
5. Price Breakout Open interest Bullish Traders caught on
rises during trend to the wrong side of
consolidation continue the market are
forced to abandon
their position and
aid the rise
6. Rising Prices Decline in Bearish This is due to short
open recovery than
interest@ genuine demand.
greater then Money flowing
seasonal out . Once short
storm recover stops price
will decline.
SR
NO
7 Prices are Open Bearish As long as this process
declining interest due to continues it is bearish
rises new shot but once it stops
more positions bullish phase will
then opening start.
average
8 Prices Open Bearish Discouraged traders
Decline Interest Sign wt long position. Once
decline oi stabilizes at lower
level rally will start
again
Variable No 2

Rollover Analysis
Rollover starts a week before the
settlement date.
Change in open interest contracts can be
interpreted as indicating the contracts
that have been rolled over.
On June 16 the open interest positions is
75000 for July it is 2700. On July 1 the
open interest positions for July is 88000.
this means substantial portions of one
month nifty open positions have been
rolled over.
OR DOES IT?
It is possible that the investors who
closed their positions where different from
the one who initiated new positions in the
July Contract Cycle.
We can just look at the open market
position and find out what it means in
terms market direction.

Again the composition of open interest in

terms of long and short position is now
available as a result ascertaining trend
becomes very difficult.
There is no delivery based linkage
between the futures and cash market and
hence there is no direct link. But if the
rollover figures are better than as
compared to previous cycle it may help in
improving the sentiment.
Variable No 3

Basis and Basis Risk

Normal and Backwardation

Ifthe futures price increases relative to

the cash price basis strengthens and vice
versa
Nifty spot =2180 nifty futures 2200
basis= 20 points
By the time investor unwinds the position
basis has weakened to 10 points

Discuss the implications???

Basis risk is the unfavorable change in the
basis from the time hedging was initiated
to the time that it is closed.
A weakening hedge aids a short hedger
A strengthening hedge aids a long hedger.
Variable No.4

Daily Trading Volume

Volume represents the total number of
shares or contracts that have changed
hands in one day trading session while
open interest are the total number of
shares contracts that have been bought/
sold but yet unsettled.
price volume Open Market Change in Market
intere
st

rising up up Strong New Money entering

bullish Market

rising down down Bearish Money Leaving Market

Declining up up Weak Aggressive new short

Bearish selling

Declining down down Bullish Selling will liquidate

position ending the
downward trend.
Interesting observations
Volume measures market activity
Open Interest gauges market participation
In a bull market volume has a tendency to
increase on rallies and decline on
reactions
In a bear market volume increases on
declines and decreases on rallies
Trading volume increases dramatically at
tops and bottoms in the price chart.
Volume and Open interest are useful
guides especially when they deviate from
usual pattern

What if the market is reaching new levels

with a drop in volume as compared to
previous high. Discuss the implication?