Illiquid Options

Options are, in general, less liquid than stocks, since traders just trade one stock whereas for options they have a variety of option contracts to pick from.

Illiquid Options Identification

A good way to check for an illiquid option is to check the difference between bid and ask price also called the bid/ask spread. If the spread is too wide(meaning if buying and immediately selling an option results in a sizeable loss) and if the option contract also has low trading metrics(i.e. low Volume and low Open Interest), then it is quite probable that the option at that strike price is Illiquid.

Strike Price Symbol Change Last BID ASK VOL OPEN INT
$20 StockA12xx 0.10 0.12 0.35 0.75 0 1

Sample Example

For instance let's say stock A for a strike price $20 has a BID of $0.35 and a ASK of $0.75. What does that mean? Let's say you want to buy 10 call option contracts. Your total cost will be 10 times the cost of 1 contract(0.75*100) or 10*(0.75*100) = $750.

If you go ahead and immediately sell these 10 call options you will be able to sell them at $0.35(BID) only or 10*(0.35*100) = $350 only, meaning a $750-$350 = $350 loss or $350/$750 * 100 = 47% loss without even the stock price moving or without any days passing by.

Furthermore, if you have incorrectly chosen an Illiquid option then either you'll have to hold it all the way till expiration(cannot close position) or you might get an unfavorable price while closing the position.




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