lystn

Hey everyone, Kirk here again in optionalpha.com. Welcome back to the daily call. Today, we are going to be talking about liquidity concerns when you're selling options and three things that you can check really quickly as you’re starting to build out your trades. The first thing you have to understand is that as we build out our auto-trading software, we are going to be building in some liquidity screens or protections that are going to be in there, so that you don't ever end up trading or the auto-trading software ever ends up trading something that isn't at least more liquid than something else. We want to build that into our software. That’s something that we’re going to be doing as part of that roll out. When you are looking for trades manually and you want to check liquidity, there’s a couple of things you can check. One, just check volume and open interest. This is pretty easy. But you'll see either good volume that are open interest or not. You don’t have to say that it has to be above 1,000 contracts a day or 100,000 contracts or 10,000 contracts. There's no benchmark to say anything has to be anything. But what you do want to be is be cautious that you are not a big fish in a small pool. We still want to be small fish in a very big pool of liquidity. And so, that's going to be relative to different things that you’re trading because different things have different prices and different contracts have different spreads that are open, like strikes that are open, so half strikes versus full strike, etcetera. But you generally want to look for good volume and good liquidity across the board. That's important. The second thing you want to look for is a very tight bid ask spread. If there's volume and liquidity, the bid ask spread should take care of itself. But sometimes it doesn't and sometimes there's lightly traded or light open interest because new strikes have just been opened up. Maybe there’s a recent move in the underlying, so the market is now opening up new strike prices at a higher or lower price, so there might not be a lot of volume, but the bid ask spread is pretty tight because people are now trading it. If you start to see a very tight bid ask spread, always a good sign of liquidity. Wide spreads which are super wide, not a good sign of liquidity. The third thing that you can check for really quick is just neighboring strikes. I look at this as like “What does the entire trading block look like?” And so, it’s very similar to maybe like in this case, real estate. Are all the houses nice in the neighborhood or is there one really nice house and everything else is falling down? If you see that on an option pricing table or an option chain that only two or three strikes have all the volume and liquidity, yeah, it might be great to trade those two or three strikes, but do you really want to get yourself in a position where you’re selling options and then have to adjust and nobody's there to adjust with you, nobody's there to make adjustments to a different strike other than the ones you initially sell? For us, what we like to see is we like to see neighboring strikes, basically, the entire trading block to have lots of liquidity, great volume, great open interest. Again, just look at SPY versus pretty much anything else. That’ll give you a good frame of reference for what great liquidity looks like. Until next time, happy trading!