When it comes to Options Liquidity?
What’s the most sensible thing you have ever heard someone say?
Look at options open interest before entering into any trade. That is it. Options Open interest sounds very straightforward and easy.
Open Interest Is Not a Good Indication of Options Liquidity.
I have made this mistake for years. Unusual Options trading strategy can be a killer with weak options liquidity.
Makes Adjustments Possible
Options adjustment is crucial for higher profits in options trading. You could check the options adjustment checklist to understand right attributes for options adjustment.
One of the most important things for options adjustment is liquidity.
Liquidity makes it easy to manage Delta & Theta. The absence of liquidity would force you to compromise with Greeks Management.
Liquidity for a particular option will change the price of the options during execution of the options adjustment. Options Trading is all the more volatile now the liquid makes it even harder to do options strategy aptly.
Investing in Options is a Myth
Fundamentally options are hedging tools for underlying asset or stock investment. The options days to expiry range from few days to few years.
Many find opportunities in holding options over a period of year or more. They treat options as an investment, and even low liquidity does not matter to them.
To an extent acceptable in put options because they act as cheap insurance. But use options strategy as an investment even if open interest is very high is not a good idea.
Now even if you are executing options strategy for a long term and treating it as investments two things could happen. Firstly you could be losing on theta, secondly, if you survive theta loss and make a profit. You would not be able to take home the profit because while exiting the options strategy liquidity would be a major challenge to exit. And this could lead you to a loss in the profit which could not be worth the risk and trouble have taken to execute the strategy.
Option Open Interest as Liquidity
The difference between option liquidity and open interest is very high. This is mistaken by most people. Even the professional trader make this mistake.
Option strike prices with high open interest could not be liquid enough to carry trades. Mostly the options as a cheap insurance for your investments could be treated as high liquidity, but the high open interest in these strike prices could be mistaken as high liquidity.
If you have mistaken open interest as liquidity, you could be making money in short-term. The probability of your lasting long with this strategy could not be long.
I have had a very good strategy which was giving me reasonable returns also. But few bad trades because of liquidity cost me a lot of money. This is the price I paid for not keeping liquidity as my top priority. Not understanding the difference between the open interest and liquidity.
Importance of Booking Profit
The most important thing for any trader or investor is profitability. Only when you can get out of your trades profitable, you are making progress. Very often we are a victim of progressive disruption, we just for the progress we take high risk only to realize that we have fallen below than what we earlier were.
Dealing in illiquid stock can be a hindrance in profit booking. Your actual and accrued profit may vary very highly.
Your trading strategy would give you multiple indicators which may lead you to a mixed decision and very often ends with a wrong decision.
This is the most important point. All other points can be managed with alternatives. But there is no solution for this point, and it has to be obliged for this purpose very strictly.
We recommend in our Options Mentoring Course that most of the first time options traders should start with 45 Days to Expiry to max 60 Days to Expiry. Strictly trade only in the Nifty Index fund for over an extended period of time before shifting to any other underlying.
Giving you a grip on options trading because in nifty index options trading records the highest number of transactions.
Hindrance in Scalability
Overcoming all the above hindrance which is very tough. You are successful in building an income generating options trading strategy.
You have started small thinking you will scale it up once you have successfully generated income over a period.
When the time comes to scaling up, you would have a very tough time. Certain strategies can generate income in options trading when the amount deployed is minimal. But as the number becomes higher things change altogether.
The tools for your order filling in options trading strategy also changes when you are dealing with very high volumes of transactions. Every for order filling and exiting the trade you would require tools without which it would be very tough for orders to get executed.
A strategy at the end of the day if it’s not scalable then it fails to achieve success in long term.
Another important aspect which very few understand the importance.
Profit and profitability both are important in any trade. If you are successfully overcoming all the above challenges, the margin would be a tough nut to crack.
Becuase of illiquidity, your last traded price would change drastically, and this would lead to margin triggers.
At the end of your trade you might be for profit but for the risk, you have taken profitability might be compromised. Higher margin means more money is deployed which in turn requires you to perform much better.
The gap between the bid and ask in this kind of illiquid derivatives is usually very high.
The gap between bid and ask price could be affecting your profitability directly. Moreover, this gap could be affecting you at entry and exit but could eat up a majority of your profit.
I have had few students who had entered into illiquid options with high open interest. Believe you me they had a tough time to get out of the trade. They had executed 12 months days to expiry options, and they would spend hours together to find a buyer for their options.
They were long in options, so they escaped the embarrassment of getting calls from brokers for margin money. Few other who have shorted deep out of money 360 DTE had very tough time maintaining their margins. Now and then they would get calls from broker to keep up with their margins.
Illiquid when Market Makers find it too risky
The main reason why market makers avoid illiquid derivatives is that they are high risk.
The reason why market makers find it risky is that they are too volatile. Since they are volatile, the margin requirement is very high. Higher margin requirement puts pressure on performance. The pressure on performance leads the person to take increased risk. High-Risk High Returns leads to undeterred losses.
Might as well avoid illiquid options trading.
Keep in mind the above reasons before you enter into a options trading. Keep options liquidity as the top priority.
Option Trading Liquidity: Things I Wish I’d Known Earlier.
These are compelling reasons why you should stay away from the illiquid option trades. Just like the pros do.
Most Common question all the time. The Biggest Problem With Options Trading Liquidity, And How You Can Fix It?
Fixing it is not worth the effort.
You Should Spend More Time Thinking About Options Trading Liquidity.
Let us know if you have any other questions or comments regarding options liquidity.
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Also published on Medium.