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Let's say the Future of an index is in Long or Short Covering status.

Now this could mean two things:

  • Traders might have a directional upward move of the underlying index. Hence, they are buying future contracts.
  • Traders might be using the future to hedge against the underlying index as they think that the underlying might do down.

Am I missing something here?

I'm confused about this. Based on the Future's status (Long, Long unwinding, Short, Short covering), how can we know what is the market's sentiment about the underlying index?

  • I don't understand the problem you're raising. If the status is Long, you have the first bullet point. If the status is Short Covering, you have the second bullet point. If you allow both, you have both bullet points. This looks quite reasonable. Can you please edit your question to explain the part that you've found perplexing? – Lawrence Sep 2 at 10:34
  • Are you perhaps trying to say that in both Long and Short Covering, people are buying the stock, but for apparently opposing reasons? – Lawrence Sep 2 at 10:36
  • @Lawrence Yes, I'm trying to say what you have said in your second comment – user5155835 Sep 2 at 12:26
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I no longer know much about futures but open interest is the same in both the futures and options markets.

Open interest represents the number of contracts that exist on any given day. There are 4 scenarios:

  • (1) BTO and STO = Both parties are initiating a new position (one new buyer and one new seller) so open interest increases by one contract

  • (2) BTC and STC = Both parties are closing an existing position (one previous buyer and one previous seller) so open interest declines by one contract.

  • (3) STC and BTO = If a contract owner sells to a new trader, open interest does not change.

  • (4) BTC and STO = If someone short a contract buys from a new trader, open interest does not change.

(1) creates a new contract

(2) a contract ceases to exist

(3) and (4) the contract is just changing hands

In all cases, there is a buyer for a seller, each with an opposing view. In isolation, this tells you nothing about market direction.

Total volume doesn't move price. Net excess buying volume moves price up and net excess selling volume moves price down.

With options, a call buyer is bullish. If that call purchase is to hedge a short position in the underlying, the trader is actually bearish. There's no way to infer what their bias is from just seeing the call purchase and possible change in open interest. To that end, some delve into combining price, volume and open interest to determine direction. I've never been able to discern it but here's an article from Investopedia that explains it.

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