Open Interest Is NOT a Stockpile (Here’s the Real Math)

Key Concepts

• Open Interest: The total number of outstanding derivative contracts (options or futures) that are not yet settled or offset.
• Delivery Eligible Open Interest: The total open interest that could potentially result in physical delivery of the underlying asset.
• Flow vs. Stockpile: Understanding open interest as a dynamic flow of contracts rather than a static stockpile.
• Denominator Error: A miscalculation arising from using a single-day snapshot of open interest as the denominator when calculating delivery percentages.

Understanding Open Interest as a Flow

The core argument presented is a critique of a calculation claiming 98% of open interest resulted in delivery. The speaker contends this figure is misleading due to a fundamental misunderstanding of what open interest represents. Open interest isn’t a static “stockpile” of contracts, but rather a dynamic “flow” of contracts entering and exiting the system.

To illustrate this, a bathtub analogy is used. The water level in the tub represents open interest at a given moment. Water flowing into the tub represents new interest being added (new contracts being opened), while water flowing out represents deliveries or contracts rolling over to another month (effectively, another “tub”).

The key point is that even if the water level (open interest) remains constant – inflow equals outflow – a significant volume of water (contracts) has still moved through the tub.

The Flawed Calculation & Denominator Error

The speaker identifies a critical error in the original calculation. The calculation incorrectly used a single-day snapshot of open interest (the water level at one moment) as the denominator when dividing by the total amount of deliveries (the total water drained). This is described as a “denominator error” and is fundamentally flawed.

“It’s a fallacy to just look at the amount that came out and divide it by the amount that’s in the tub. That doesn't make sense,” the speaker states, emphasizing the logical inconsistency.

Correct Approach: Delivery Eligible Open Interest

The correct approach, according to the speaker, is to calculate “delivery eligible open interest.” This involves summing all open interest that passed through the system during the relevant period – both the initial open interest and any new contracts added during that time. Essentially, it’s tracking the total volume of water that flowed through the tub, not just the level at a single point.

This means adding up everything that was “in the tub and all of it that came through the faucet” throughout the entire period under consideration.

Data Availability & Practicality

The speaker acknowledges that obtaining the necessary data to perform this accurate calculation is challenging. The numbers are not publicly available from COMEX (Commodity Exchange Inc.) and would require significant “investigative work and math” to piece together.

Furthermore, the speaker questions the practical value of this corrected calculation, stating, “It would be a lot of effort…and how valuable would that number be? Probably not that valuable.”

Implication for the 98% Figure

While a precise recalculation isn’t presented, the speaker confidently asserts that the true percentage of delivery would be “definitely a smaller percentage than 98%” if the correct methodology were applied.

Logical Connections

The argument progresses logically from establishing the concept of open interest as a flow, to identifying the flaw in the original calculation, proposing a correct methodology, and finally, outlining the practical limitations and expected outcome of the corrected calculation. The bathtub analogy serves as a consistent thread throughout, reinforcing the core concept.

Conclusion

The primary takeaway is that interpreting open interest requires understanding it as a dynamic flow, not a static stockpile. The 98% delivery figure is likely inaccurate due to a fundamental mathematical error – using a single-day snapshot of open interest as the denominator in a percentage calculation. While a precise recalculation is difficult, the speaker convincingly argues that the true percentage of delivery is significantly lower.