Apr 21 2008
Warning Sign: Open Interest Declining
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I was taking a look this morning at the open interest in the S&P futures - both the full sized contracts and the mini ones. Ever since the turn of the year, OI has been very low by recent standards. Basically, there’s been a pretty massive deleveraging in the US stock market. Given what’s been going on in the credit markets, that’s really no suprise.
The problem I see, however, is that OI has been drifting lower of late as the market has been generally moving higher. That’s not something which can be taken positively. It can be read to mean one of two things. Either longs are being closed out or shorts are being covered. Neither of those developments is the sort of thing to provide ongoing support to for a rising market. We would want to see OI rising, meaning new longs being established.
It’s all a really interesting tug-of-war going on in the markets right now.
Here are some other posts which might interest you:
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OI rising certainly does NOT mean new longs are being established. Well, kinda-sorta, but it misses the point.
OI rising means that new longs AND new SHORTS are being established.
Every contract of OI is a long and a short position. What you’re seeing is a decrease in speculative interest on BOTH sides as OI decreases; I don’t know if that is bullish or bearish in and of itself …
Bill - I didn’t mean to imply that rising OI is only bullish or only bearish. It could be either, or it could be neither. My larger point was, as you noted, that decreasing OI indicates descreasing involvement in the market, not increasing. Generally speaking, we would want to see increasing involvement, especially on the long side among certain players (COT data), just as we generally want to see increasing volume, to be supportive of sustained upside.
When was the peak OI? I’m betting it was the day of, or right after, the March retest. This would mean that speculative interest peaked at what was seen as a possible reflection point for the market (retest and bounce or breakdown and crash), and now that the point has resolved, there is less speculative interest - which should be expected, considering.
Volume isn’t OI.
Again, the peak volume of contracts was at the retest, which is where everybody’s betting on that reflection point - it makes sense that, as they settle into recognition of a bottom and support, speculation would slow down.
FWIW, I have seen only tenuous and untradeable correlations in past changes to OI versus future changes in futures prices, but I’ll take a brief look to see if changes in OI tend to reinforce price trends, one way or another.
Actually, OI peaked at the time the futures rolled from March to June as the front month (about a week before expiration). That’s nearly a week after the March lows and the volume peak (3/13 using the SPY). It does that each quarter. In most quarters there tends to be a gradual increase in OI over time, which accelerates into the rollover period, and then plummets right after the roll.
That also coincides to the high volume periods in the futures as volume in the contracts also tend to ramp into the rollover.
But to me the more interesting view is what’s going on in a more general view. In particular, the post Dec. rollover low was much lower than previous troughs, and that month’s high was also much lower. (I’m looking at the full S&P contract, not the minis here). That’s the point I was making about the market’s deleveraging around year-end.
After the Dec low, OI did rise into late Jan., but then went flat until right before the rollover when it ran up aggressively. That peak was higher than the Dec one, and the following trough afterward was as well. Both, though, are lower than the ones before December. And while there was a bit of a pick up in OI into the end of March, it has actually been drifting lower all April.
In terms of testing, I wouldn’t test OI against price change by itself. I would use it with volume. For example, if volume is increasing and OI is not, that means position churning.
Yeah, there was nothing with change in OI, and changes in OI combined with changes in price said nothing. Changes in volume and OI together may say something …
I was looking at SPs, but the numbers I have are spot, OI, volume, and then the OHLC for continuous contract backadjusted, so I’m not totally sure about the volume and OI numbers, I would assume they’re a total or mix from the contracts used for the continuous adjustment — highs were just after the March lows so could have been rollover — would probably want to adjust for seasonality if the rollover spike is a quarterly event — it’s gets bigger and bigger as you think about it — for something I wouldn’t trade on.
I’m still thinking the increasing evidence of a bottoming is what drove the OI down, when compared to volume and OI in a market price downturn and fears of an economic collapse. If that’s the meme, than the lower OI goes along with futures traders believing we’ve bottomed - and whether that’s bullish or not is a smart money/dumb money sentiment issue.
OI is definitely an aggregated figure counting all contracts. I’ve never seen it split out that I can recall. Volume is normally contract specific.
You would definitely want to account for that quarterly roll for the purposes of practical usage. It’s a very obvious pattern.
I won’t disagree with the idea that short liquidation into what could have been perceived as a bottom. That makes perfect sense. It’s coming out the other side, though, where you’d like to see OI rising as long players started coming in. That’s not happening and it continues to be the small players who are the most bullish (looking at the COT figures for the mini S&Ps).
[...] value of the open interest data (as Bill Rempel and I were discussing yesterday - Warning Sign: Open Interest Declining) is in its ability to highlight whether traders are building positions (more participation) or [...]