Open Interest and Underlying Trading Volume: Why the Link Varies

Summary

The post asks whether rising options open interest is generally associated with more trading in the underlying asset. One answer cites an older study reporting increases in market depth, volume, trade size, and trade frequency, along with narrower spreads. It then extrapolates from the fact that option open interest begins at zero to suggest that increasing open interest may raise underlying volume. That reasoning is presented as an inference, not as a demonstrated causal result.

A second answer cautions that the relationship is not necessarily direct. It explains that some markets arrange delta exposure off-exchange when options are initiated, while market makers may hedge residual delta with the underlying and use other options for much of their rebalancing. The expected effect therefore depends on asset class, market conventions, and trading practices. The discussion is qualitative and does not provide enough detail about the cited study to assess its scope or establish a general empirical relationship.

Key ideas

• An older study is cited as associating options-market activity with greater depth and volume and narrower spreads.
• The post’s claim that rising open interest increases underlying volume is an extrapolation, not a proven causal conclusion.
• Market makers may offset delta outside the underlying or use other options, leaving only residual exposure to hedge there.
• The relationship depends on asset class, market conventions, and individual trading practices.

Tags

# changes in open interest vs changes in underlying volume


# changes in open interest vs changes in underlying volume












Has a relationship been noted?

Mostly, I'd like to know if the open interest increases on an underlying, does the underlying usually see increased trading?

My guess would be "yes" since MMs can only mostly hedge with the underlying, and they must constantly rehedge (buy or sell) the underlying everytime the underlying changes, possibly as volatility futures, interest rates, etc do too.

## Answer by user3232 (score 0, accepted)

https://quant.stackexchange.com/a/7685

Old (1998): http://bbs.cenet.org.cn/uploadimages/2003931633961531.pdf

Says that depth, volume, trade size, and trade frequency increase while spread decreases.

Since open interest is 0 before options trade and > 0 after, I'm going to extrapolate and say that increases in open interest increases underlying volume.

## Answer by Matt Wolf (score 3)

https://quant.stackexchange.com/a/7610

"does the underlying usually see increased trading?"

Not necessarily. Most market makers do not re-hedge much in the underlying. In many markets the delta is exchanged (off-exchange) alongside the options trade at initiation, making both parties delta neutral at the outset. Re-hedges in large vol books are generally accomplished through other options and only residual delta is hedged in the underlying. But it obviously depends on the specific asset class and market convention as well as individual approach to trading such options. I am just saying that an academic paper will not be able to cover all those ifs, again it depends on above-mentioned variables.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.