Low liquidity of options

October 24, by Bret Kenwell Liquidity plays an important role in all markets.

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No problem. If you have money in the market and need it out, you could have it that same day depending on the account and time of day.

How Do We Measure Liquidity?

Even worse, say you need to sell your home to raise cash. One could have their home up for sale for months — even at attractive prices — and still not get a worthy bid on the property.

Just as fashions come and go, investors tend to favor certain stocks, bonds, or futures contracts. The result is a larger pool of buyers and sellers for some tickers, while others sit idle with little to no trading activity. In the more active markets, the increased participation makes it easier to take new positions or exit existing ones without affecting prices too much. In market lingo, such investments have liquidity.

Real estate is an illiquid asset. But there are subtle nuances in the market where liquidity plays a role.

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The options market exacerbates these principles and makes liquidity even more important. But as liquidity dries up, that spread widens dramatically. It makes it almost impossible to exit at a good price. When volatility spikes or volume declines, that spread tends to widen rather than shrink.

Say that option goes from at-the-money to in-the-money to deep-in-the-money.

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Rather than cashing in after making the right call, investors may face an even wider spread — even if volatility remains low. This can make exiting a position difficult given that the spread is wide and there will likely be less buyers and sellers at that particular strike.

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Even non-volatile low liquidity of options can have incredibly wide spreads. This can be especially true for deep-in-the-money options or options with far-off expiration dates. They can often times get a price somewhere in the middle.

How is options liquidity determined? Can options liquidity be calculated?

The lower the volume and wider the spread though, the harder it gets. The more traders in the strike, the easier it is to get the price you want.

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If you low liquidity of options 2 people on a soccer field, a perfect 50 yard pass will be difficult. If there are 10 people 5 yards apart, the passes are easier.

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That scenario can be thanks to low liquidity and it can be a dangerous scalpel to our performance. The first would be to simply look at the spread.

By Chad Langager Updated Mar 1, An option is a financial instrument that gives the holder the right to purchase shares in a company at a certain set price strike price before a set date known as the expiration date. Options, however, trade far less frequently than other financial instruments such as stocks or bonds. This can make it difficult for investors to enter into the option that they want.

Investors can also look at the open interest, which shows how many open contracts are currently being held by investors.

They can also look at volume to get a sense legal earnings on the Internet how many contracts have changed hands in the current session.

When these numbers are higher, liquidity tends to be higher as well. When these numbers are low — and can be zero, for the record — then liquidity tends to be pretty tight.

Why Is Liquidity Important?

Keep in mind that even with lots of volume and plenty of open interest, spreads can still be wide if the underlying asset is volatile. In a nutshell, there are a lot of contributing factors to liquidity. For tight, small moves though we need high liquidity to get in out and quickly and at good prices.

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Luckily, Option Party has a few filters we can use to take advantage. Combined with its overhauled implied volatility filters and investors can really do their best to ignore these low liquidity plays.

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