I personally prefer open interest leaves (or beans). Btw the paper riskarb referred to confirms the pinning effect. A math model is described here http://www.ima.umn.edu/talks/workshops/4-12-16.2004/avellaneda/qf3601.pdf I beg to think many folks dislike it because it's just a helluva lotta work to sift through. Moving averages are a lot easier...
This is what I think... There is a way to gain some benefit from OI. You can interpret OI. Big OI numbers are at meaningful strikes. In the options chain, you wont see big OI at random strikes. Therefore to find meaningful strikes, see big OI numbers. These meaningful strikes signify support and resistance, and psychological levels. Therefore by looking at the options chain and its big OIs, u already know what the market sees as support and resistance levels and psychological levels (psychological means 100, 25, 50, that kinda thing) Also the 2 academic papers in this thread say there is 'pinning' or 'clustering' towards the big OI strikes as expiration nears or on expiration date itself. It basically means the underlying price will cluster or get pinned near to its options strikes. But how to interpret it, as to its direction, I agree it is not reliable. Except in this following manner: Choose an option inside a big OI if you are an options buyer, and outside a big OI if you are a seller. Because by being inside/nearer to big OI, you are not being hampered by s/r and u let the pinning help u. By being outside/ farther, u use the s/r as your friend as well as pinning, so it will be harder to touch ur short option. That's one way I can think of.
That's an interesting take on OI. It incorporates the "max pain" strategy mentioned with a possible way to take advantage of it. Thanks for the input.
My own conclusions: Gigantic stocks are much harder to manipulate, also if the market is going in the wrong direction. Big open interest on puts is a better indicator than big open interest to calls, as you don't know if those who manipulate bought or sold the calls.
Wouldn't the same logic apply to the puts? How would you have knowledge of who may be manipulating those? It is possible with various spread strategies isn't it?
1) An option trade is never long or short, it's just "open" - every buyer is matched with a seller. 2) Determining who initiated the option trade is difficult to impossible, depending on the market. 3) And even if you knew who initiated the trade, how do you know if it was speculation or a genuine hedge ? 4) How can you be sure there isn't an offset in the back months ? 5) Even if you knew who initiated the trade AND you knew it was speculation, what makes you think the speculator is right ? 6) With so many variables and uncertainties, why bother monitoring open interest at all ? Could your time not be better used elsewhere, like technical analysis or reading tea leaves ?
Just for the record, there are a couple of folks who would disagree about Open Interest. Take a look at the most recent Options Expiry. For anyone with historical data, you might be interested (no joke intended) in looking at the prices that got tagged on the upswing and then on the downswing. Some of the strikes got squeezed and they just happened to be those with big OI. Larry McMillan uses a simple running total of OI to calc the odds of having an edge on expiration day. Interested parties can go buy his book "Profit with Options" published by Wiley in 2002 (I think). On page 146 he talks about his system for using OI. Steve