OPTIONS NUTSHELL: EVALUATING UNDERLYINGS FOR OPTIONS LIQUIDITY
(1) Not every underlying is "options liquid."
(2) Avoid trading "options illiquid" underlyings with options.
(3) Average share volume, the availability of both monthly and weekly expiries, the availability of one-half to dollar-wide strikes, and the tightness of markets are all indicators of option liquidity.
(a) Average Share Volume. Look for underlyings that trade at least two (2) million shares on average. This doesn't mean that the underlying will have liquid options, but is a starting point to weed out thinly traded instruments that are unlikely to have liquid options.
(b) Monthly/Weekly Expiry Availability. Underlyings with liquid options tend to have both monthlies and weeklies.
(c) One-Half to Dollar-Wide Strike Availability. Underlyings with liquid options tend to not only have dollar-wide strikes available, but also half-dollar wides, although this will vary to some extent on the size of the instrument. Larger instruments may have less "granular" strike availability, but smaller instruments should have comparatively more.
(d) Width/Tightness of Markets. Avoid trading underlyings with options in which the differential between the mid/bid and/or mid/ask is greater than 5% of the credit received (assuming it's a short premium setup; it's the converse for a setup for which you're paying a debit) is a good rule-of-thumb.
Next Up: Trade Metrics for NonDirectional Premium Selling (Short Straddles/Strangles, Iron Condors/Iron Flies).
(2) Avoid trading "options illiquid" underlyings with options.
(3) Average share volume, the availability of both monthly and weekly expiries, the availability of one-half to dollar-wide strikes, and the tightness of markets are all indicators of option liquidity.
(a) Average Share Volume. Look for underlyings that trade at least two (2) million shares on average. This doesn't mean that the underlying will have liquid options, but is a starting point to weed out thinly traded instruments that are unlikely to have liquid options.
(b) Monthly/Weekly Expiry Availability. Underlyings with liquid options tend to have both monthlies and weeklies.
(c) One-Half to Dollar-Wide Strike Availability. Underlyings with liquid options tend to not only have dollar-wide strikes available, but also half-dollar wides, although this will vary to some extent on the size of the instrument. Larger instruments may have less "granular" strike availability, but smaller instruments should have comparatively more.
(d) Width/Tightness of Markets. Avoid trading underlyings with options in which the differential between the mid/bid and/or mid/ask is greater than 5% of the credit received (assuming it's a short premium setup; it's the converse for a setup for which you're paying a debit) is a good rule-of-thumb.
Next Up: Trade Metrics for NonDirectional Premium Selling (Short Straddles/Strangles, Iron Condors/Iron Flies).
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