#63 - Should You Only Trade Highly Liquid Options?
Hey everyone, Kirk here again at Option Alpha and happy Thanksgiving. On today’s daily call, we’re going to be answering the question – “Should you only trade highly liquid options?” First before we begin, very happy Thanksgiving to you. If you’re listening to this on Thanksgiving, I appreciate the support on a holiday. That is by no means what I expected. But my goal and my promise to you guys has always been to get out a new show every day, so Thanksgiving is no exception. But I want to take one moment to say I do appreciate each and every one of you. This has been a long, long journey for me and something I plan on doing for a long time. I thoroughly enjoy being here. I love running Option Alpha. I love meeting the people and interacting with a lot of people online. It’s definitely a work of passion for me for sure and something that I don't necessarily consider to be work because I like doing this. I like talking about the markets and so hopefully, you enjoy everything that we do. Again, I just want to say I’m very thankful for everyone in the community and the people that we built up around us, our team on Option Alpha. If you’re listening to this and editing this podcast, thank you as well. Again, getting back to our topic of the day which is really – “Should you trade only highly liquid options?” I think the answer here is it depends to yes. More often than not, I think there’s an overwhelming case for trading highly liquid options as the basis of everything that you do. I say it depends because it depends on what your goals are. If your goals are in trading options to generate monthly income, to be basically agnostic to the market, meaning you don’t care where the market goes or if the market goes up or down or you’re not tied to any one security, then yes, I think you have to trade highly liquid options. The reason that you have to trade them is one, because you need quick and good pricing on fills and really, you just need a lot of choice in strike prices to use, the ability to ladder into different positions, the ability to adjust contracts. There’s so much that liquidity allows you to do and so many (no pun intended) options that liquidity allows in your account that it’s like these unforeseen forces that you don't run into had you not traded liquid options. With trading liquid options, what I think about liquidity, I think about just the biggest, the best, the most widely traded ETFs and stocks out there. That’s really the basis for the watch list software that we built in our toolbox program. We always go out and scan basically every quarter. We look for stocks and ETFs that consistently have high liquidity, small bid ask spreads, a penny or two or three pennies wide at some cases. We look for stocks that consistently show those characteristics. Now, it may not be that a stock is liquid this month, but it might be more liquid certain times during the year or whatever, every other month or during earnings, whatever the case is. We’re always looking for consistently the most liquid securities that we can trade. We can just pull that data. Anybody can pull that data from various market resources and sources out there. It’s not something that’s proprietary for us. It’s just we scan for it and we do the heavy lifting for you on our end. The other side of this coin though us if you don't trade liquid options, I just say that you have to be careful in how you do it. I would say that you should scale back your position size dramatically. I would say that you should be very cognizant of which strike prices you get into because if you look at something that has low liquidity, you might want to focus on the strike price that has higher activity than normal. Oftentimes, what I see when people try to send in stocks to me and they’re trying to get my opinion on everything, I’ll just glance at the liquidity and I’ll look at it and eight out of the 10 strike prices on that option pricing table have zero open interest, zero volume, basically nobody is trading them. They’re just out there available, but nobody’s doing anything with them and maybe one or two strikes out of the 10 might have some liquidity. Now again, I highly suggest you don't do this. You don’t trade those securities. But if you are for some reason, whatever reason it is… I’m not going to tell you not to do something if you have your heart set on doing it. Just make sure that your position size is insanely small. You don't want to be a big fish in a small pond. You definitely want to be a small fish in a huge ocean of liquidity in the options market. The good news is though that options trading continues to grow in popularity, in liquidity and volume. It's definitely something that has not seen any real dramatic drop-offs year by year definitely judging by CBOE data, etcetera. Options trading continues to grow in exponential rate which is good because that just means more liquidity for all of us. It just means more choice, more availability in securities eventually. I think ultimately, it’s going to be a very good thing to see more people in the options market. Hopefully this helps out. Again, if you’re listening to this on Thanksgiving, I really appreciate your time. I am humbled that you took the time on Thanksgiving or anywhere around Thanksgiving honestly to listen to this podcast. Go enjoy some time with your family and friends. Until next time, happy trading!
