Trading Options - Look For Liquidity
If you're interested in trading options, then it's a good idea to always look for options that are highly liquid. What does this mean? Basically, it simply means that there are lots of people all trading the same options as you. That's important, because it means there's plenty of supply and demand. If you need to exit a trade, you want to be reasonably confident there will be someone out there wanting to buy into it - and that's what liquidity gives you. There are plenty of options that only trade at low levels, and these are generally referred to as "illiquid" options. If you trade in illiquid options, and the market moves against you, it can be very difficult to exit your open positions. You might have to accept an even bigger loss, simply because you had to drop your price so much further before finding a buyer. It's no fun, with a trade going against you, to sit and watch your profit being eroded away minute by minute, because you can't find a market for your position. Unfortunately it can happen far too easily with an illiquid option. The best way to avoid getting stuck in a losing position is to only trade in liquid options and strike prices. That takes some discipline, because it's very easy to be tempted by the opportunities that regularly present themselves in the illiquid portion of the market. But don't be fooled - restrict your focus and you'll be a more profitable options trader as a result. It's often a good idea to pick a handful of stocks that have very liquid options, and focus on those. Becoming extremely familiar with just a few stocks and their charts makes it much easier to see the patterns of the stock's price and take advantage of them. Remember, though, to periodically confirm that the options for that stock are still very liquid. Over time the liquidity of individual options can vary enormously, so do an occasional review, just to be on the safe side. If you want to be even more careful, it can be worth working out the average liquidity for a stock's options, and only trading those that are above average. To do this, add up the open interest levels available for each stock, and divide by the number of options available. That will give you an average.
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