As an Options Trader in today’s electronic markets you have the advantage of transparency. Market Prices are in front of you all of the time. You can use a live feed of Options Prices to evaluate numerous Options Trading Strategies and determine which Strategy meets your risk/reward requirements. In addition, you can quickly evaluate the Liquidity of the Market and whether algorithms are competing with you.
Whether you are Trading Stock, ETF or Futures Options, there is a high probability that the opposite side of your transaction is not a customer like you but more likely a market-maker or algorithmic trader. Market makers can provide tremendous liquidity to markets. In contracts like SPY, AAPL and GLD (representing SPDR S&P 500 Trust ETF, Apple, Inc. and SPDR Gold Trust ETF) it doesn’t matter who is providing the Liquidity because the markets, in most cases are reasonably tight. In other markets, however, Speculators and Hedgers are required to compete in an environment that is not particularly competitive and therefore a long-term burden to the cost effectiveness of Trading Options.
If you have ever put in an order in an illiquid market, you are likely to have seen the actions of the algorithms. Typically, if you offer an Option at a Price less than the current Offer the algorithm will Offer the Option at an even cheaper price. This is an attempt to get you to Sell the Option for even less. This is where an algorithm is able to make enormous profits by trading with Options Traders who are not aware of value. Imagine that each and every order to either Buy or Sell an Options Contract meets this scrutiny; the individual trader has a distinct disadvantage. It is for this reason that trading contracts with the greatest liquidity is essential.
In the movie Trading Places the open-outcry market provided transparency and liquidity. While it may not have been a perfect system, open-outcry in its purest sense provided each customer transaction with the opportunity for full disclosure. Now, with computerized trading and algorithms dominating the markets, your order is gobbled up long before it can be exposed to numerous market participants. The Table below provides the Bid and Offer and liquidity percentages of a multitude of instruments. The markets with the lowest liquidity percentage are most likely to provide the best value in terms of trading.
While evaluating Liquidity Percentage is important to be sure you are getting good value, using the market’s Implied Volatility Skew to determine the best Options Trading Strategy to meet your objectives is also essential. For those who are interested in getting Short the Stock Market and would like to avoid the syndrome of Buying expensive out-of-the money Puts and Selling comparatively inexpensive out-of-the money Calls, the attached Options Trading Strategy provides the combination of Liquidity and Excellent Value. It is a Strategy that is most effective for traders that are interested in Hedging or being Short Stocks for at least a period of several weeks. The example shown below is for the July Options Expiration on SPY (SPDR S&P 500 Trust ETF).
The Strategy involves taking advantage of the Implied Volatility Skew of SPY Options to generate a Short Position with excellent value. The Table clearly provides the transactions that are necessary to initiate the position and while now may not be the time to implement it, the technique is available most of the time when you are trading SPY Options or those of the E-mini S&P. If you have questions about this Strategy or what we consider the essential part of any Options Trading analysis: 1) Liquidity, 2) Historical Volatility, 3) Implied Volatility, 4) the Implied Volatility Skew and 5) Options Strategies, take a look at our website at Options Strategy Network for PowerPoint Presentations and a Syllabus to evaluate your level of Options Trading expertise.
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.