Open Interest – Is It Always Meaningful

Agree or disagree, a lot of traders pay attention to open interest in a given security. This makes a lot of sense in individual equities, ETF’s and indexes. The reason open interest matters so much is that the more open interest, typically, the more liquidity there will be in that given month or strike. Understanding open interest can help a trader improve execution (something that, in my opinion, is far more important than commission rates).

However, open interest can also be misleading in certain circumstances, especially in the SPX and the OEX. If we go back to my last post where I explained calculating a VIX future using combos, the same concepts apply to the OEX and the SPX. Traders can trade ‘synthetic futures’ on the SPX or OEX by using a combo.

In the SPX especially, combos can throw off open interest on the months traders call ‘the quarterlies.’ These are the months that correspond to the actual S&P 500 futures. For varying reasons (that I may bring up in a future blog), often customers want to ‘tie’ their option trades to the S&P 500 futures when trading a large order in the SPX options. Rather than try and cross an actual future, the traders will trade a synthetic future using the SPX options. In executing the synthetic future brokers, to make the math easier, almost always use even strikes of the 50.00 dollar strikes. This can cause the open interest in the quarterly months to be distorted higher. While there is by definition open interest produced by the combo, in practical terms there is not.

Here is an example:

A trader buys 1000 of the SPX April 1275 calls tied to June Futures on a 50 delta.

Rather than sell 500 S&P futures, the activity that might hit the tape would be:

Buy 1000 April 1275 calls

Sell 500 June 1200 calls

Buy 500 June 1200 puts

A synthetic position of short 500 futures was created by selling and buying SPX June 1200 calls and puts.

While the 1200 strike options did trade, I do not effectively see them as having any effect on actually opening interest on the 1200 strike. While there are other reason the June 1200’s have so much open interest (one being the length of time the strike has been listed), synthetic futures have certainly assisted in the large open interest on the June 1200’s.

Mark Sebastian