Open Interest for Futures Traders

Open Interest is the total number of futures contracts in a futures market that have not been closed out by an offsetting transaction, by delivery of the underlying commodity or by cash settlement.

When a new delivery month for a futures contract begins, there is no open interest because there are no futures contracts being traded in that delivery month.  As trading builds up for that delivery month open interest also increases.  Towards the end of the delivery month for that contract open interest declines as positions are closed out, rolled into the next delivery month or delivery of the underlying commodity for that futures contract is fulfilled.

Open interest increases when a new buyer takes on a new long position and a new seller takes on a new short position.  This transaction creates a new futures contract, and open interest increases by one.

Open interest stays the same when a new buyer purchases an existing long position that is being exited, or when a new seller purchases an existing short position that is being exited.  Open interest stays the same because no new contract was created since the position was offset.  A new buyer / seller purchased an existing long / short position.

Open interest declines when an existing buyer and seller are offsetting their respective long and short positions.  Open interest declines by one contract because these are existing positions.  Long and short are exiting the market, long is selling his / her position and the short is buying his / her position back and no new customers are involved.

Open interest decreases when the delivery of a contract is made.  The person holding the short position delivers the contract and a long accepts delivery of the contract.  Open interest declines by one contract because the two existing positions, long and short, were closed out by delivery of the contract.

There are only 3 ways to close out a futures contract

1. An offsetting transaction - an existing long and short create an offsetting transaction
2. Physical delivery - the commodity specified in the futures contract is delivered, delivery is accepted.
3. Cash settlement - instead of a commodity being delivered, the cash value of that commodity is paid out to the buyer.

Open interest is usually highest for the nearby contract month.  When you are looking at open interest, it is important that you look at the total open interest,  for all delivery months, not open interest for the individual months.  

The total open interest will give you a better idea of the liquidity of the futures contract, which is important for getting in and out of the market at the best price possible.  Low open interest means low liquidity, which leads to poor fills and exits, slippage and lost money.  The total open interest will also give you an indication of the direction the futures contract may be trading, or trending, in.