To know things from an intricate perspective, the perpetual futures markets are not only comprised of limitless orders. To know the finer details, except by the quantum of orders placed by buyers and sellers. Other key factors play a crucial role and one of them is an Open Interest Rate. When it comes to open interest rates, the definition is simple. It indicates the total number of options and futures contracts available to be traded in a specified time window. It also illustrates the amount of cash inflow and outflow. Depending upon an increased cash inflow for a specific contract or sets of contracts, the demand is determined.
To make things simplified, if there is more cash inflow, there is an increase in interest rate. Eventually, the increased interest rate then results in more demand for the underlying asset and its relevant contract. Whether the contracts are perpetual futures or mere options contracts. While, on the contrary, if there is a decrease in the interest rate and there is a cash outflow. Linking to lower demand for the underlying asset and its contracts (future and options). To know things from a wider perspective, we must know the mechanism of how things work.
How Open Interest Rates Determine the Perpetual Future Contracts
Open interest is a nice and convenient indicator for stepping into the futures market. Whether you are trading stocks, commodities, or crypto, the futures markets, the latter serves the common gauging criteria. In case you are starting from a hybrid exchange (HEX) such as Bitflex, you would come across future products. There are many centralized exchanges as well that are just a dual version of centralized banks or CEX. Such exchanges are common to trade and dealing in with the crypto future side.
On the other hand, the rising and falling interest rates are commonly indicative of demandable and lucrative contracts. To understand how the math around open interest rates works, we must do simple addition and subtraction. But we are devoid of knowing how many futures perpetual contracts, as well as options, are out there. Simply, sell and buy contracts have no distinction, to classify how many buy and sell contracts are placed. The count covers the total number of buy and sell contracts opened versus closed contracts of the latter. Let us look at how this works.
- Person A enters a long trade and decides to buy 8 long contracts. The open interest rate increases to 8.
- Person B enters a long trade and decides to buy 9 long contracts. The open interest rate would cumulate to 17.
- Person A decides to exit the trade and sells his 8 contracts. The open interest rate would decline to 9.
- Person C enters a short trade and sells his 3 contracts. The open interest rate would be 12.
- Person A (Enters) (+ 8 Long)
- Person B (Enters) (+ 9 Long)
Open Interest rate= 17
- Person A (Exits) (-8)
Open Interest Rate = 9
- Person C (Enters) (+3 shorts)
Open Interest Rate= 12
Open interest rates are remarkably calculated when there are countless contracts placed. And it is more difficult to ascertain when the same person is entering into simultaneous contracts at the same time. Furthermore, the perpetual futures open interest rate deviates when one party places the entering and exiting contracts in unison. This makes the assessment complicated at the same time. Sometimes two people are opening and closing the trades simultaneously.
How does Futures Open Interest Rate Deviate?
The open pointers to know where the market would eventually go depend on the volume and open interest rates. Both go side by side. In the 2020 bull run, when the market was overleveraged, everyone plunged into the market. No one stayed away, even grandmas were leveraging their portfolios. With the downward rally, the BTC showed extensive shorts. But longs and shorts together do not decide what would be the open interest rate in this situation.
When you invest in crypto, make sure you assess what the current open interest rate is. Along with this, you can also check on the volume of the market. To know where you can find the open interest rate for the asset you are going to make a buy or sell the contract. Make sure you know the other indicators too. The most popular one is RSI (Relative Strength Index). Coupled with various other indicators you can make a pragmatic decision. To enter and exit and know the current rate, many trading applications such as Trading View provide an open interest rate.
When we get into the perpetual future contracts, we closely observe the funding rate. The funding rate is a periodic payment made between traders for perpetual futures contracts to come close to the index price.ice. Whereas index price is marked by considering the bucket prices of major spot crypto exchanges.
An Indication of Reversal
Similarly, if the price of an asset is falling and there is a relevant increase in the open interest rate. Then, it is a clear indication of new shorts contracts entering the market. Whereas if the price of the asset is increasing and open interest is decreasing, there are more long contracts entering the market. It is a clear indication of market reversal. The following table would help you understand with clarity.
Price of An Asset Open Interest Rate Market Condition
Increasing Increasing Strong
Increasing Decreasing Weak
Decreasing Increasing Weak
Decreasing Decreasing Strong
With the above-discussed indicators, you can expect a reversal to appear. This would help you in judging the trends and what kind of perpetual future contract you may need.
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