Options Liquidity: How to Avoid Slippage — Full Breakdown & Transcript

[00:02] coming at you with another episode of options in action where we take older whiteboard videos and we bring them to life in the platform with some more advanced tactics and tools for you as an active trader. We've talked about

[00:14] everything under the sun so far. I think this is like the 20th or 25th one we've done. I lost track already, but we are talking about getting filled on options and I think this one's really interesting because there's not there's

[00:28] advanced lens we can look at getting things that I think everyone should understand when you're looking at risk trades. There's some big implications there. There's an

[00:41] absolutely big implication when you're looking at one leg versus four legs trying to get filled there. So we'll talk about it all in the platform today SPX. The Fed just told everyone that they are

[00:54] keeping rates the same and the market rallied like 40 points from the lows. So still a crazy market. We've got Microsoft and Meta earnings coming after the close today. So I'm sure there's still some realized volatility,

[01:06] but let's take a look at the platform and we will cover everything you need to trades. So first things first getting filled on options trade depends on whether you're buying or selling an option and it also

[01:19] depends on what product you're trading, right? A lot of people say spy is the poster child for options liquidity and I would tend to agree. You've got 5 cent wide markets here. If you look at any options expiration,

[01:33] you're going to be able to get filled pretty close to the mid price, which is what is deemed the fair price for options trading. So the mid price is just the distance between the bid and the ask. So if I wanted to sell the 730

[01:46] strike in this random 6-day cycle, spy has plenty of liquidity here, tons of open interest across the board and tons of tons of volume as well. So if you're just look at the open interest, which is the outstanding contracts for that

[02:02] contract itself. How many open contracts there are is synonymous with open interest, and then volume is how many how many contracts traded today. So, today we've had 100 1.19k trades in the 730 strike, and there's 1.2k open

[02:19] over time, so you can kind of see whether they're closing or opening orders with big volume numbers and reduced open interest, that means these contracts are closing. The opposite is true. If you have low open interest one

[02:32] day and then bigger open interest with high volume the next day, that might indicate that there's more opening trades. So, just a quick uh little tip there, but volume and open interest and then the bid-ask spread are the three

[02:44] liquidity. So, if I wanted to get filled here, if I was selling or buying this, if I'm selling this option, you can see the uh price. So, the closer I bring my price down to the

[03:00] bid, the more probabilistic it is for me to get filled. The mid price is 311. Let's just lock this and we can uh take a look here, but 314 mid price, 306 bid, as we we just uh rallied 20 points in the E-mini. So, this might be a tough

[03:16] example here, but regardless, the mid price is the distance between the bid option, you're going to want to move it closer to the bid price to get filled in The closer you move it to the ask price or further away from your natural price

[03:31] of getting filled, uh you're going to have a a harder time getting filled quickly, but you you'll have a better favorable price if you are filled. If I'm selling this option and I'm trying to sell it for more than the mid price,

[03:43] The market would have to drop in the value of this option to get me filled at that limit price. So, limit orders are uh the way that we

[03:55] like to enter and exit trades. I don't like to use market orders too can kind of get slapped on the wrist a little bit if you If I wanted to sell this option and and routed as a market order, it's going to instantly fill, but

[04:08] I don't have any control over whether that price is good or bad for me. It's usually going to be worse because, again, the speed of getting filled on an options trade is largely related to how close you are to the natural price,

[04:21] which in this case of selling an option is lower than the mid price. On the flip side, if I were buying this option, I would have to get closer to the ask price, which you can see on the platform switches to the natural price,

[04:33] and I'd have to increase the price in getting filled quickly. So, all that to say, if you're trading spy, routing it for the mid price, you're immediately because there's tons of liquidity here. There's tons of people

[04:47] whether you're looking at a 6-day cycle, 7-day cycle, a zero day, there's so much activity in spy and QQQ and and other products that are household name products that I don't see that there's going to be too big of an issue.

[05:02] Now, one thing that you can run into is when you start to build more complex strategies. So, instead of just buying that 730 put, maybe I'm selling a spread. Maybe I'm doing the 732 730 put spread here. What you'll notice is the

[05:15] bid ask starts to widen, and that's because you're now no longer just you're dealing with two options contracts. And if I route this as a spread, the market maker has to fill

[05:28] both of these legs before I can be filled on the package. So, the more legs you add to an options strategy, whether it's just a put spread or an iron condor, you'll start to see that the more legs you add, the wider the bid ask

[05:40] spread gets. That doesn't mean you won't necessarily get filled at the mid price. certainly get filled at the mid price within a couple seconds here, but the more illiquid the product is, the

[05:53] harder time you'll have with getting filled. So, one way I like to see visually whether a product is liquid or not is how many weekly options If there's a ton of weekly options expirations in a product, that tells me

[06:07] that there's enough liquidity for the market to open those weekly options expirations. So, you look at spy, there's tons. You look at the Qs, a ton. Then you start to go into some other

[06:21] products like Lockheed Martin maybe, you start to see, okay, less liquidity, less weekly options expirations, and at a certain point they're not listing weekly options expirations past September. So, this is a product that is inherently

[06:37] less liquid than something like spy. With that said, that doesn't mean that these options are untradable, but the bid-ask spreads in like Lockheed Martin are significantly worse than a product like spy. So, we

[06:51] look at the same sort of thing. Okay, maybe I want to sell a put in Lockheed Martin in September. Well, these markets are insane. You could drive a boat through these bid-ask spreads. 860 bid, 1440 ask. That is almost a thousand

[07:05] dollars between the bid price and the ask price. So, if you're asking involved in these markets? First of all, look at the bid-ask spread. How narrow Uh and then look at the volume and open interest, what we just talked about as

[07:19] well. Very little volume here in September, only six contracts traded today, and a hundred people are in this. Like this is not an option I want to be involved with. Even if I got filled at the mid price, and I sold this option,

[07:31] or maybe I got filled at a better price, and I'm like, wow, I just I just tricked the market. I'm I'm in. I'm filled at a better price than the mid price. Not so fast. You have to close that position by buying it back. So, now you're on the

[07:44] buy this option back. Nobody's involved flying around and you're in a profitable trade, you might have to give up two, three, four, five hundred dollars from

[07:56] out of the trade, which is known as slippage. The value that you're giving up to get out of a trade is known as slippage. So, obviously, we want to reduce slippage as much as possible by trading really liquid markets, sticking

[08:12] to those household names. A big red flag for me is if I go to a a stock that Twitter or somewhere else. If I go to a stock and I see zero weekly options expirations, which are shown by this darker shade here. If I only see like

[08:26] three or four monthly expirations, I'm not trading that product. That tells me that there's not enough liquidity within that product for them to open up weeklies or open up, you know, seven or eight monthly options expirations. And

[08:38] like you see here, there's only a handful of expirations that are even tradable. Only a handful of strikes that are even tradable. So, this isn't one Uh, you know, there's a difference between some of these weekly options and

[08:52] monthly options, of course. One thing to note is with earnings reports, you're liquidity because everyone's trading the earnings reports. Uh, that's where you might have an uh, a peak in liquidity.

[09:05] So, keep that in mind. If you're trading earnings and everything looks good, just longer data cycles. See what the bid ask rate looks like because just because doesn't mean they'll be here tomorrow or the next day. And you might see that

[09:20] liquidity dry up and it might create a problem getting in and out of trades. terms of liquidity. I will say, if you're trading something like SPX, don't don't get it twisted. I mean, SPX is a $7,400 product. You might

[09:35] look at these markets and be like wow, not much volume, not much open interest, spread here and there. This is such a liquid market that you're still going to be able to get filled pretty easily here. And that's

[09:49] there's still thousands of people trading these contracts even if you're trading, you know, one below or you know, 7395, 7390, something like that. wouldn't worry too much about it, but utilize those limit orders, right? Make

[10:04] sure that you are picking your price to get in and out of trades, being patient. If you route a trade, let's say I want to sell this put spread in SPX, if you want to get filled at a good price or you want to do a little price discovery,

[10:18] in between the bid ask you can get filled, just route it for something closer to a favorable price for you. Route the order, submit the trade, and if it doesn't get filled, you can always right click directly on it, click

[10:31] replace, and then bring it down 5 cents, re-route it. Don't get filled, perfectly fine. Right click and replace, bring it down 5 cents. So, there's nothing that costs you anything to do a little price

[10:44] rather do that than just route a market order and get filled at some random price. Because again, if you're trading something super illiquid, you can be at the mercy of a really bad fill and that can wipe away all your profits or a lot

[10:58] of it. So, let me know what you think when it comes to liquidity and how you're analyzing bid ask spreads and sticking to super liquid products, but I liquid the product has to be just because the market maker has to fill all

[11:11] of those legs before they give you an order fill. If you're dealing with a product that doesn't have weekly options expirations, SPX, spy, there's plenty of weekly options expirations which tells you there's tons of liquidity for them

[11:24] to open them up. But if I see any product that only has four or five Cuz tells me there's not enough activity in there for them to open weekly options expirations. And products like SPX spy

[11:38] any issue trading those because they're so deeply liquid. So again, let me know what you think in the comments below in the YouTube chat as well. Subscribe to video if you haven't already, but we'll see you on the next episode of options

[11:53] see you on the next episode of options in action.