Options Liquidity Check in Apple, Amazon, GLD, Alphabet, SPY and VIX: Don’t Give Up the Edge

Option Traders are always seeking the perfect environment for Trading. I would describe the perfect environment as a tight market with no commissions. Unfortunately, Bid/Ask Spreads get in the way and I can't do much about commissions. You're on your own. If you were able to find the ideal market all you would have to do is find the appropriate Options Trading Strategy to meet your risk/reward requirements. At that point, your Trading results would truly be a function of your ability to Trade.

Finding a market that provides a Trading environment with an essentially flat market (one where the Bid and Ask are the same) is impossible yet if you are Trading Options finding Options Contracts with tight Bid/Ask Spreads is essential to long-term profitability. The Table below evaluates the liquidity of Options Contracts in Apple, Inc. (AAPL), Amazon, Inc. (AMZN), SPDR Gold Trust ETF (GLD), GOOGL (Alphabet A, Inc.) SPDR S&P 500 ETF Trust (SPY) and the CBOE Market Volatility Index (VIX).

In evaluating Liquidity, or what I define as the Bid/Ask Spread percentage of the out-of-the money Options, you only need to take the difference of the Bid and Ask Prices and Divide it by the Price of the Options you are Trading. The larger the percentage, the less liquid the Option. Every time you give up the edge on a Trade it costs you money. Analyzing Liquidity may help save you a significant amount of money by preventing you from entering trades that are too costly to establish as a percentage of the price of the asset you plan on Trading. For example, some Option Contracts have a liquidity percentage of 10%. That means that you are giving up 10% of the asset price to enter the transaction. In addition, you will have to pay an additional Liquidity percentage to liquidate. Add in commissions, and you have to be quite a good trader to make money. If you are unsure of the contents of this article: Contact us.

The Table below (a snapshot of Bids and Offers from this morning) provides out-of-the money Options Prices for select Options of the Symbols chosen above. In order make a reasonable assessment, I’ve tried to select Strike Prices with Option Values approximately the same price. This way we can examine the liquidity of similarly priced Options. As you can see the Liquidity percentage is the lowest in SPY, GLD and AAPL. The other instruments have significantly higher Liquidity percentages. This means that every time you trade AMZN, GOOGL or VIX Options you are giving up a comparatively larger edge. The more edge you give up, the more likely you are to lose money.

Trading Options successfully involves a strong understanding of basic Options Concepts and the ability to evaluate Implied and Historical Volatility, the Implied Volatility Skew and the appropriate Options Trading Strategy to meet your risk/reward requirements. Even with a strong understanding of those concepts, if you are Trading markets that lack Liquidity, you are not going to make money in the long-run. Evaluating Liquidity is easy; just be sure you are using out-of-the money Options. The underlying contracts were chosen because they are extremely popular, the question is, does the liquidity they provide make them the appropriate contract for you to trade.

Options trading involves significant risk and is not suitable for every investor. The information is obtained from sources believed to be reliable, but is in no way guaranteed. Past results are not indicative of future results.

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