Why In-the-Money Call Open Interest Does Not Predict a Stock Selloff
Summary
The document challenges the claim that a large amount of in-the-money call open interest creates a large supply of shares at expiration and therefore predicts a sharp decline. It explains that each open option contract has both a long and a short side. Exercise and assignment transfer shares between those parties at the strike price; by themselves, these mechanics do not establish net selling pressure in the underlying stock.
The example of offsetting option positions illustrates how substantial gross open interest can coexist with little or no net share demand. The argument is conceptual rather than an empirical study, and the document does not quantify how dealer hedging or changes in positions before expiration might affect prices. Its main lesson is that open interest alone does not reveal the direction of market exposure or justify a directional forecast.
Key ideas
- Each open call has both a long holder and a short holder, so open interest does not show net market exposure.
- Exercise and assignment transfer shares at the strike price but do not by themselves imply net selling.
- Offsetting positions can produce large gross open interest with no net share transfer.
- Open interest alone is insufficient evidence for predicting a stock's direction.
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# Can a large OpenInt of calls cause a stock to go down? # Can a large OpenInt of calls cause a stock to go down? I read forum post from another site. Which stated... ``` XYZ has 60k+ CALL contracts are in the money for this Friday vs 5k PUTS. That will be extra 5,500,000 supply this Friday. Big drop! Chances of XYZ being green tomorrow = 0% 4 mln shares supply (20% daily volume) from OPEX imbalance will accelerate profit taking run. ``` My question is... is this a technically valid statement? if so why?... What happens to the underlying when someone closes or exercises an in the money call that causes an addition to the daily volume of a stock? Thanks! ## Answer by John (score 3, accepted) https://quant.stackexchange.com/a/20630 This is not a valid statement. Most obvious reason is that this situation would provide an arbitrage opportunity for those that take the 30 seconds to check open interest :-) But more specifically for every call that is in the money there is a person (firm, hedge fund . . you pick) that is short the call and another person (etc) that is long it. Simply put, the long will exercise, lose the value of the option but get the stock for the strike price . . .a net wash (assuming it is exercised at expiry and no time premium is foolishly thrown away). The short option holder gets to keep the option premium but will have to deliver shares to the long call holder at a price below market value . . .again, a theoretical scratch. Another interesting point. Much of the open interest in options is tied up by market makers and hedge-funds that may in fact have a net 0 holding of calls. For example, 2 traders a&b. Stock trading 100, trader a long 100,000 of the 70 calls and short 100,000 of the 75 call (note the massive 200k open interest on the in the money call side representing 20 million share equivalent). Trader B has the exact opposite position. With expiration just days away both options are trading at parity and both trader a and trader b will have no shares to buy or cell as, for example, trader a will exercise his 100,000 70 calls and trader b will exercise his 100,000 75 calls with the net effect that each trader exercises or is assigned on all of their options with a net share transfer of zero. Hardly the making of a volatile situation in either direction hope this helps John
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.