newbie question---low volume options

I

indo

I would greatly appreciate answers to the following questions:
1. Options with low open interest and low volume, how easy is it to get out of them and is the market price of the option strictly based upon the price of the stock and time to expiration? I've seen options with no volume on some days and there is a huge difference between the bid/ask.


2. I would also like to know what happens to an in the money option which reaches the expiration date? Ie A call option where the price of the stock is much higher than the strike price.

3. Finally what s the least amount of open interest would you recommend when trading less than 10 contracts.


Thanks
 
1. If you are willing to pay the full spread (i.e. buying on the ask, selling on the bid) then it's not hard to get in/out of low open interest, low volume options, assuming you are trading 10 contracts or less.

2. Options that are in-the-money by 0.01 at expiration are automatically exercised. if you don't want an option to be automatically exercised then you need to notify your broker by the cutoff time on expiration Friday.

3. The more the better.
 
thank you for your reply and information.


I dont know why there is such a huge difference between the bid/ask on low volume options if the value of the option depends on the price of the stock and time to expiration. Maybe for a newbie its better to just stick with the large volume options.
 
Quote from indo:

thank you for your reply and information.


I dont know why there is such a huge difference between the bid/ask on low volume options if the value of the option depends on the price of the stock and time to expiration. Maybe for a newbie its better to just stick with the large volume options.
More...

the bigger the delta of the option the wider the market will be relative to the other markets. so all the deeps will be wide. also, there is not a need to be aggressive on displaying option prices for options with little volume. market makers also want more edge to trade illiquid products.

i think those are the major reasons they are wide.
 
Quote from indo:

I dont know why there is such a huge difference between the bid/ask

There are a bunch of possibilities. here's two

1) The market makers leave wide markets on the screen so they don't have to be bothered with keeping an eye on the quotes.

When a live order appears, that's when the buyer or seller can discover the real market.

My opinion is: if you are forced to buy the offer or sell the bid to get the trade done - forget that specific stock and find something else to trade.

2) Some people are dumb enough to pay the offer (or sell the bid), without making any effort to get a better price. Why advertise a discount if your customers don't demand one.



on low volume options if the value of the option depends on the price of the stock and time to expiration.


The value of an option depends on more than that.

It has a significant dependence on implied volatility.

It also has some dependence on supply and demand, but in this case, there is essentially neither.

It also depends on the market maker's positions. They nudge markets higher or lower depending on whether they would rather buy or sell options.

the point is that is more complicated than your description.


Maybe for a newbie its better to just stick with the large volume options.

You don't have to go that far, but avoiding ultra-low volume options is a good idea.
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Mark
http://www.expiringmonthly.com/
 
Quote from MTE:

1. If you are willing to pay the full spread (i.e. buying on the ask, selling on the bid) then it's not hard to get in/out of low open interest, low volume options, assuming you are trading 10 contracts or less.

...
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Ahahahahah. :D

Was that meant as a joke, or did it just turn out to be one?

Newbie: How hard is to fly?
Answer: Well, if you are a bird, or you have a 747 and know how to operate it, it is not that hard. Really it isn't!
Newbie: Oh wow. Ok thanks! You guys really know your stuff.
 
thanks for all of your help guys, it makes a lot more sense now. I'm only going to be using options to hedge my equity positions.
 
Quote from indo:

thank you for your reply and information.


I dont know why there is such a huge difference between the bid/ask on low volume options if the value of the option depends on the price of the stock and time to expiration. Maybe for a newbie its better to just stick with the large volume options.
More...

In my opinion:

The main reason the spreads are monster wide is that the option exchanges have been able to keep a monopoly on making markets. Joe public is not allowed to make markets so there is no competition. If anyone could both bid and offer at the same time most option spreads would narrow and the volume would increase greatly. While this would be great for anyone other than a market maker its a crime in my view.

If your new to options I recommend that you avoid them. They appear to be a lot more simple than they really are. Also if just by glance you have seen wide spreads take a look at the spreads when a stock is moving very quickly and is not a top 200 by volume stock. Any edge you could have goes away very quickly when you have to get out due to risk management.

There is one area though that I really like about options and it can minimize some of the downside. If there is a stock that you want to buy or short EVEN after it would make an adverse move than shorting options can be very good. The caveat though is that you have to be able to properly price it to make sure your receiving a better than fair price (no edge if your not doing better than fair).

Black-Scholes as well as some other calculations do NOT properly calculate for "black swan" events so what may appear to be properly priced may in fact not be. Like I said its complicated so do a lot more homework on the subject then you think you had to before touching them.

Again, just one traders opinion and I always have someone on the other side of my trades who has the dead opposite opinion.

Best to you

Robert
 
Quote from Robert Weinstein:

In my opinion:

The main reason the spreads are monster wide is that the option exchanges have been able to keep a monopoly on making markets. ...
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No.

The reason they are wide is not because there is some conspiracy to keep them wide. The exchange itself would love nothing more than for every option to go penny pilot since it would increase trading and therefore revenue.

The real reason has a little to do with greed, but it also has to do with much more mundane things like the mm does not have the technology to keep up with quotes, so wide quotes protect him from being picked off. Another reason could be that the stock is very volatile. MMs need to be compensated for delta risk, as well as for every second derivative. Of these second derivatives, only gamma is taken into consideration by black-Scholes. Finally, if there is very little open interest in the option, the MM certainly doesn't want to be holding the bag with most of the open interest with someone that probably knows more than he does about the stock. Sadly, wide spreads keep the open interest low, so it is a vicious circle.

Still, there are some options that are absurdly wide, unnecessarily. For example, I wanted to enter into ETR today. I don't think the ATM straddle optins should be .30 to $1.00 wide. That is ridiculous. So I forgo the trade.

Penny pilot is revolutionizing options trading for the retail trader. Only the most sophisticated MMs can cope with penny pilot.
 
Quote from nitro:

Ahahahahah. :D

Was that meant as a joke, or did it just turn out to be one?

Newbie: How hard is to fly?
Answer: Well, if you are a bird, or you have a 747 and know how to operate it, it is not that hard. Really it isn't!
Newbie: Oh wow. Ok thanks! You guys really know your stuff.
More...

Well, it wasn't really meant to be a joke. The OP asked how hard it is to get out of illiquid options, and the obvious answer is that it's not hard if you pay the full spread.

I agree though that it does sound like a joke.
 
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