Options traders, quick ? about option liquidity.
I'm in IB, but I enjoy trading options on the side. I've done fairly well and several of my better trades have been relatively illiquid options (particularly those with little liquidity more than 3 months out).
My question is, I've always had stops and limits to exit my trades and at the respective values, the brokers I use (TD Ameritrade, E-Trade, Fidelity) never seem to have an issue covering, despite low liquidity.
Should this actually be something I am worried about going forward or is the liquidity risk overblown with options?
For example, I traded ECPG options a few times.
Disclosure: I do not currently hold any ECPG options or underlying stock.
Yes, liquidity is ALWAYS a concern in trading, not much more to say about it than that.
However, this entirely depends on the size you trade, and you may face a situation where you can't get out in the future. I would suggest judging a maximum position size for the event where you cannot exit, and not going beyond that limit when putting on future trades. This size can be a % of open interest.
In short, plan for the worst-case scenario and potential available liquidity whenever you would like to exit.
Thanks, I guess I've just been lucky to this point. I knew liquidity was always a concern, but I guess my trading sizes were still small enough.
Options are not that bad anyway. Worst case scenario you lose 100%. You should be careful when you trade things like futures, where you can lose way more than 100% fairly easily. Just size your positions according to the fact that you might not be able to get out, but options have an intrinsic stop at 100%.
Yea, but I'm was more concerned with being able to exit my position. I rarely hold until expiration, I have concern about flipping them once I'm up say 20%. I want to be sure that I can get out of the position.
I see your point. Then yeah, you should definitely be very careful with your orders or you might not get filled or get a horrible fill (illiquid options tend to trade in a choppier way)
Hmm... This question actually picked my interest and I did some extra research.
Ok, so there's the usual stuff like a wide spread and market-maker shenanigans to protect their end of the deal. The key here is just to trade small, and stay small.
The bit I hadn't known about though, is that you can offset a position by buying/shorting shorting stock. This is called "same day substitution" and allows you to "exit" an illiquid position. I would suggest talking to your broker about this to get all the details.
In any case, in my options trades I'd always considered the premium to be my stop loss. Say I only risk 1% on a trade, then that should be the premium's max worth (i.e. for a $10,000 account, the most I'd pay for an option is $100). This accounts for the event where there would be no possibility of exit and keeps the loss small. If you're considering months-long trades, you can maybe risk up to 3-4% (that would be my personal max).
Hope that helps.
Tandem, very good info. Thanks. I'll definitely contact my broker about the "same day substitution". Good point about trading small. In regards to that, is there any number of contracts or % of open interest I should stick to?
That's not same day substitution. Same day substitution is to have offsetting PnLs in positions in a margin account so you don't get a margin call, but your losing position is still losing. What you are referring to is more or less delta hedging. You offset your exposure to the underlying by actually buying/selling the underlying in an amount proportional to the delta of your position. Therefore, a move in the underlying won't change your PnL. But you would still be exposed to the other risks of the option, so you are not exiting the position, you are just hedging ONE risk. You can still get fucked quite easily, typically in vol or if you have a short gamma position. So don't go buying the underlying stock and then thinking you're out and your PnL is not going to change.
Thanks for the clarification Maximus. Sounds like there really isn't a way exit or swap out of the position. All I could do is hedge.
No, it appears Same-Day Substitution is a specific action when it comes to options (it is otherwise as Maximus stated -- a P&L offset) whereby you offset a current position in order to exit it without paying the spread or needing to hit a bid/offer. Here is an article on the process since I can't find anything in the OCC.
I would definitely talk about this to my (your) broker for the technical details. They'll know way more than us. :]
P.S. In the future, ALWAYS DO YOUR RESEARCH!!!!! Especially with options. Know the details. I've been burned myself in options because I didn't know how a specific mechanics worked. Simply do not trade until you know what you are doing. You will save a lot of money in the long run. Trust me. :)
No. I'm afraid I didn't explain myself correctly or you didn't understand that article. Let me have another go.
Same day substitution is like I told you, a way of offsetting PnLs so you don't have to post extra margin so you don't get a margin call. It has nothing to do with options, it has to do with trading on margin. In that article it assumes that you are buying or selling the stock on margin, not with cash, which is were same day substitution comes in. In the example they put, you don't have to post extra margin because the PnL from exercising the options at the end of the trading day becomes the margin you need to hold the stock, so you are offseting one with the other. It is EXACTLY the definition of same day substitution.
The process of using the stock to offset your option position is, like I told you, delta hedging. Like I said before, you would still carry all your other risk, unless of course you do it on the expiration day and you are planing on exercising the option. But your article is absolutely irrelevant, the OP said he does not wish to hold the options until maturity, nor convert them. So the process is absolutely useless to him, and like I said, best he can do is hedge is delta and take care of the other greeks as best as he can. Plus the article is quite bullshit, getting hold of stock can be very difficult and expensive on option expiration dates, specially if it's an illiquid stock, because a lot of people might be covering their options positions which don't always match cash positions, which can move the stock the wrong way for you and get you in lot of trouble. I don't trade equity single name options, so maybe derivstrading can pitch in, but I can tell you that this is not a viable option for what the OP was asking.
Fair enough, I stand corrected.
If there is any way to salvage an illiquid options position, I'd like to know as well.
i've done some call and put spreads through my own online account, and i've never really had any issues getting out when needed, even on low liquidity stocks...most of the time it'll get covered, maybe not at what youre looking for, but within a few points
Thanks Tony. As I stated, I'm not opening large amounts of contracts, so like you, I probably just haven't had any issues.
I cant really speak for US options, i think screens are more liquid there, but messing around in illiquid options is dangerous business on European screens. If you are going to do it stick to German names, the screens on those are very tight even in shit stocks, but i regularly see screens being quoted as 20-120 imp vol, and theres just not much point playing in those,
Interesting... keep the advice coming fellas.
I don't see how you can make money trading illiquid options unless you are delta hedging.
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