Option Volume and Open Interest
When trading stock, the trader measures stock market activity & liquidity by volume. In options trading, there are two forms of measurement: Open Interest & Volume.
Unlike stock trading where there is a fixed amount of shares in the market, option contracts must be created to meet demand. When a new strike price and new expiration are created, contracts must also be made available to buy and sell.
Open interest is the amount of option contracts still open. They have not been exercised, offset by a sale or expired.
Open interest will increase when new contracts are created by an options buyer and seller, whereby a new buyer takes a new long position and a new seller takes a new short position.
On the other hand, open interest decreases when both the options buyer and seller close out their respective exisitng positions together and the contract is eliminated.
The option volume is the number of option contracts traded during a given period of time. Volume is the number of options contracts that changed hands from a seller to a buyer, regardless of whether it is a new contract being created or just an existing contract.
Volume also affects the bid/ask spread. If you are trying to buy an option that no one trades, the market is going to take a premium from you to create a trade in the option for you to buy. Find options with a lot of volume and compare them to low volume. You will see on a percentage basis, the spread is usually more costly.
Lastly, the spreads on out of the money options are more costly on a percentage basis than in the money. That is usually just a function of the cost of the option.
So when do you buy an option? That is personal preference combined with a little experience. TradeWithPros Educational Stock Picks suggest you simply practice buying on the open. Our education teaches that in the money options with solid trading volume and open interest are your best buys.