How Liquidity Can Make or Break Your Options Trades

by | Feb 19, 2022 | Options

I have a lot of gripes about low-volume options markets like we’re in now…  

It can be especially maddening when institutional buyers aren’t participating while the rest of us are still trading.  

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 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 options liquidity — sometimes called “order flow” — is important, especially for retail traders.  

They Call it Options ‘Order Flow’ For a Reason

First and foremost, good order flow is 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 out. 

So when we’re trading options, there are a few things traders should look for before diving in head first… 

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 the spread, the more likely you can get your order filled close to the prices you see. 

For instance, these out-the-money calls on Coca-Cola Co. (NYSE: KO) circled below show about a 4-cent bid/ask spread, with decent volume and open interest. 

Compare that to these 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. 

I 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 me show you just how critical options order flow is for options outcomes.

P.S.

I rarely get excited about a single stock…

But there’s one company that should be on everyone’s radar right now…

It typically performs well around elections…

And with the midterm primaries around the corner… I see the future looking bright for this company…

That’s why it’s my No. 1 Accelerator Stock for April 2022.

Get the details here.

WRITTEN BY<br>Lance Ippolito

WRITTEN BY
Lance Ippolito

What to read next

Have any questions? Contact Our Customer Service Team