Stocks & Commodities V. 31:7 (33): Explore Your Options by Tom Gentile

Stocks & Commodities V. 31:7 (33): Explore Your Options by Tom Gentile
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Explore Your Options by Tom Gentile

GETTING ENOUGH LIQUIDITY?

On top of the list of things that option traders look at to measure liquidity is the bid/ask spread on the option they are interested in buying or selling. The thinner the spread between these two points, the more efficient the ability to buy and sell in a shorter time period, and the more likely you are to make a profit over time. I look at the bid/ask spread the way a professional gambler looks at the edge in a casino game. Casino games and option trading are not that far off; as traders, we know there are certainties we canít overcome. The spread between what we can buy something for and what we can sell it for is one of them. Hereís how to make sure youíre trading at the closest price to the middle.

1) Look at the stock universe. There are tens of thousands of issues that trade each day, but only about 4,000 of the listed securities trade options. Which of these have the most liquidity? You may think the stocks that represent the S&P 500 basket have higher liquidity than those that do not. Going deeper, perhaps the OEX 100 or the Nas daq 100 will give us even more traded issues, hence more liquidity. Thatís a great place to start, but on an individual stock basis, itís not going to tell you which options have the thinnest spreads. My suggestion is to look at the PPP.

What is the PPP? PPP stands for penny pilot program, which was put in place by the CBOE (Chicago Board Options Exchange) a few years back. Prior to the start of the PPP, options would trade no less than the five-cent spread (bid .95/offer 1.00). This program started with just a few stocks that started trading options in the pennies. Now there are more than 300 stocks on the penny list. This list can be found at https://www. cboe.org/hybrid/pennypilot.aspx.

2) Look at the strike universe. Option strikes are plentiful, but which ones offer the best liquidity? Letís take a look at each type of option:




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