I understand that strike prices of high open interest should be important to the writers; that's where they start losing money. If XYZ is at 200 and I am short a call at 210, though, wouldn't I want to buy the underlying to cover in order to hedge a loss? What is the theory behind 210 becoming resistance? What are the criticisms of this theory?
Open interest is just interest in a instrument, usually expands when underlying is going up and often declines going down because people are afraid of concept of sell short or they say it is un-American. I have never thought of it as S/R. There are those who use Market profile based on volume and S/R.
Well, like I mentioned, if, for a given expiry, 210 has the most open interest, it functions as some sort of S/R because that is where people must start covering their naked options.
Except that's a huge assumption that even a single one of those is a naked option. They could all be part of another hedging strategy or actually indicate the opposite since bull put spreads and bear call spreads are a thing.
Sure, maybe they aren't even naked calls, but even if they are covered calls or part of spreads, they are still significant levels in the strategy no?
Not really. If I sell a put spread at 85/80 for example, you'll see an open interest at the 80 strike. I'm happy when the price of the stock falls below $80 because I get to keep all the credit, but I was also happy at any point the intrinsic value of the spread was below the price I sold it for. The buyer of that spread started losing money somewhere between $85 and $80, and for them $80 represents the point where their spread is worthless but can't loose them any more money, so it doesn't have a lot of meaning for them either. In other words, you'd be misinterpreting the tape to think there's some support or resistance at $80 in this case because neither buyer or seller have anything dramatic happen at $80 that wasn't already happening at $81 or $83. And that just represents one of hundreds of strategies that use options. You might want to do a search of the literature to find out if anyone has determined what percentage of option sales are naked directional bets on the market, that would go a long way toward answering your question. I don't know the answer to that off the top of my head, but if you find out I'd be interested in hearing what you found.
Will see if I can find any research into those topics. What if we throw institutional and market makers gamma scalping into the mix? Market makers sell a lot of options, right? And they may want to stay Delta neutral as much as possible, possibly hedging using the underlying. What if the buyer of that spread wants to scalp gamma or hedge under 80? He isn't losing any more money past there, but maybe if he scalps gamma it will recover eventually and the scalping will make up for the time value lost. And maybe the seller sees the price climbing back up and wants to hedge in case the spread becomes unprofitable? With the open interest, I'm assuming somebody wants to hedge the Delta somewhere.
What is the purpose of this thread. Are you assuming that OI can show strong S&R levels. What led you to this assumption. Are you assuming Stock Options only, or Futures Options also.
The point is to find if there is any theoretical reason that OI strike prices could indicate S/R levels. I'm not assuming, it's the point I'm trying to discern.
What I look at is the COT. For example, gold had the higheet historical non-commercials in history making it rip for a sharp drop. You will also view the changes in positions and who all the recent big players are.