Low liquidity of options, How Do I Measure Option Liquidity?

Just as fashions come and go, investors tend to favor certain stocks, bonds, or futures contracts. The result is a larger pool of buyers and sellers for some tickers, while others sit idle low liquidity of options little to no trading activity.

In the more active markets, the increased participation makes it easier to take new positions or exit existing ones without affecting prices too much.

October 24, by Bret Kenwell Liquidity plays an important role in all markets. No problem.

In market lingo, such investments have liquidity. All else being equal, the more liquidity, the better.

Why Liquidity Is So Important in the Options Market

How Do We Measure Liquidity? In the options world, liquidity can vary a lot from one instrument to the next.

By Chad Langager Updated Mar 1, An option is a financial instrument that gives the holder the right to purchase shares in a company at a certain set price strike price before a set date known as the expiration date. Options, however, trade far less frequently than other financial instruments such as stocks or bonds. This can make it difficult for investors to enter into the option that they want. The best way to measure option liquiditytherefore, is to look at two factors: the daily volume and the open interest. The daily volume of a specific option low liquidity of options is simply a measure of the number of times that contract was traded on a particular day.

In fact, there is real inequality today. Clearly, the deeper liquidity pools are concentrated in a handful of names in the options market these days.

  • Why Liquidity Is So Important in the Options Market - Option Party
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Two important indicators can help you size up liquidity: daily volume and open interest. While volume in equities is measured by shares, the volume for an option is based low liquidity of options the number of contracts traded. If, for instance, one name sees average daily volume approaching 1 million contracts, it is among the more liquid.

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  • How is options liquidity determined?

On the other hand, a ticker that sees daily volume of just a few hundred contracts is not seeing much action and might not have ideal liquidity. Open interest measures the number of contracts that have been opened and not yet closed.

Why Is Liquidity Important?

Taken together, volume and open interest can give a sense of whether an option contract is very liquid, sort of liquid, or gathering dust see figure 1.

For illustrative purposes only.

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Past performance does not guarantee future results. Why Is Liquidity Important?

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Yet, more liquid and actively traded options contracts tend to have more strikes and expiration weeks and months to choose from. That gives an investor more selection when looking to initiate strategies, including spreads, that involve more than one contract, or when pursuing a specific option cycle tied to events like earnings or dividends, for instance.

In addition, a busy market with many participants typically has narrower spreads between the bid prices and the ask prices. More customer orders increase the likelihood that investors can trade with each other, rather than having the market maker take the other side of the trade.

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Ultimately, traders are a little like wine collectors—liquid assets matter.