I have a lot of gripes about low-volume markets like the holiday week we’re in now…
Having tons of traders away from their desks can be especially maddening when trading the rest of us are still trading options.
Low trading volume can wreak havoc on liquidity, making the difference between buyers and sellers —known as the “bid-ask” spread — wider than a truck.
For the uninitiated, liquidity is basically the combination of daily volume and open interest. The higher each of those categories are, the faster a stock or option can be bought or sold without impacting the price.
There are a few more big reasons why liquidity is advantageous — especially for retail traders.
It’s Called ‘Order Flow’ For a Reason
First and foremost, good liquidity is massively important when trading options because the more contracts that are traded in the chain, the quicker our orders are filled at prices we want.
When an option isn’t widely traded, our position makes up a larger part of the market, which can cause problems…
Not only can it take longer to enter and exit the trade near the asking price, but our order can also skew premium prices out of our favor both getting in and getting out.
So when we’re trading options, there are a few things that traders should look for before diving in headfirst…
First, check the options chain for open interest and daily volume. Generally, the larger each number is, the easier it will be to trade that option.
Next, take a look at the bid-ask spread, the tighter that spread, the more likely you are to get your order filled close to the prices you see.
For instance, the December monthly out-the-money calls on Coca-Cola Consolidated Inc. (NYSE: KO) circled below show about a 4-cent bid/ask spread, with decent volume and open interest.
Source: Think or Swim
Compare that to these December monthly calls for Dick’s Sporting Goods Inc. (NYSE: DKS), where the bid/ask spread is 30 cents (or “three dimes”) wide, and both open interest and volume are meager.
Source: Think or Swim
I just don’t like these wide setups because you can get filled… and then instantly be down 20% in the blink of an eye…
So if you can, try to focus on trading options where the bid/ask spread is no more than 10 cents (or “dime-wide”).
That way, you’ll be sure and at least get the best price you can, even in a sleepy holiday market like this one.
Check out the short video below and let’s talk about
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