# Options liquidity



## aleckara (17 November 2008)

Hi all,

I have just opened an options trading account with Commsec.

Now I wanted to buy a put option. However when looking at the series (and this is a large blue chip stock) the spreads are large (for the premiums) and with the liquidity it looks like it will be very hard for me to close any sort of position on these options contracts (was looking at BHP and MQG - December). With these large spreads as a newbie it is hard for me to gauge the impiled volatility of the market and therefore it is hard for me to work out a fair price that I should bid for these options.

My question is how do options traders trade on ASX options with these liquidity constraints? Surely they pose risks (i.e unable to closeout).


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## chops_a_must (17 November 2008)

They basically don't.

Simple.


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## cutz (17 November 2008)

Hi 

Are you using comsecs webiress platform, if you are there is an option value calculator on it?

Me personally I run an excel spreadsheet which tracks 20Day HV and IV on my preferred stocks and the index. It helps me keep tab on how volatility is tracking, I also use a modeling tool which u can download here http://www.asx.com.au/resources/calculators/options/modelling_tool.htm it gives you a payout diagram and theoretical prices based on volatility inputs, anyway got to rush, I’m only a beginner, there are some pros here with will probably give you some better info. 

Cutz.


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## jackson8 (17 November 2008)

aleckara said:


> Hi all,
> 
> I have just opened an options trading account with Commsec.
> 
> ...




some may say to divide the spread and place your order in the middle.  when the underlying sp moves it may sweep you up in the process


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## cutz (17 November 2008)

Sorry,

I just realized I didn’t really answer your question, as far as spreads go they are the tightest at the money on the biggest stocks and the XJO index, as you go away from the money in becomes a pain. Market makers will be selling you high IV which could be a problem when you’re buying options.  If the underlying moves in your predicted direction but volatility drops off you still may not make a profit.


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## jackson8 (17 November 2008)

cutz said:


> Sorry,
> 
> I just realized I didn’t really answer your question, as far as spreads go they are the tightest at the money on the biggest stocks and the XJO index, as you go away from the money in becomes a pain. Market makers will be selling you high IV which could be a problem when you’re buying options.  If the underlying moves in your predicted direction but volatility drops off you still may not make a profit.




to add to that iv's are quit high at the moment so you are paying a very high premium and will need a big move to realise a profit . aleckara are you considering itm atm or otm purchase.


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## sails (17 November 2008)

aleckara said:


> Hi all,
> 
> I have just opened an options trading account with Commsec.
> 
> ...




Chops is right - very few serious options traders bother with the Oz market for the reasons you've outlined.  Fees and data are soooo much cheaper for US options and liquidity is huge.  However, some their sleep at night and have to find a way to trade Oz options. 

Personally I wouldn't touch MQG options because of such low liquidity.  I prefer the likes of BHP and learn how to negotiate the wide bid/ask spreads.  Takes time and practice - observing what happens to other retail orders, etc.  Trading combos can help - sometimes easier to get a bit closer to the mid price - but if only trading one or two contracts, the extra fee can cost more than a bit of slippage...

Slippage is a fact of life - MMs have to eat and are certainly not making a market for charity!


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## dutchie (17 November 2008)

Liquidity Liquidity Liquidity

In OZ there ain't none!


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## aleckara (17 November 2008)

jackson8 said:


> to add to that iv's are quit high at the moment so you are paying a very high premium and will need a big move to realise a profit . aleckara are you considering itm atm or otm purchase.




Thanks everyone.

I wasn't looking at anything particular in terms of ATM, ITM, OTM. I was only looking at out-of-the-money puts because I figured that if the spot price went to this price all the liquidity would be here and I would be able to close out (i.e trying to set up a protective positon) and the volatility premium on otm options is less. I can see the liquidity is currently at the atm price like I expect it to be. My concern is that if i buy the option I won't be able to close it out if I buy an atm option due to the lack of liquidity.

I have been thinking of getting involved in the US market for some time but haven't had the time to seriously look into it. I'm sure a forum search will highlight the good brokers available. However I don't want to get into trading formally as such and most brokers want you to do a few trades a month; if I have a view on a company or have a position I want to hedge I want the tools available to take advantage of that view.


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## cutz (17 November 2008)

Hello again,

If you’re buying a put as a purely protective position I guess liquidity at expiry is not much of an issue. If the option is in the money at expiry you can always exercise the contract rather than close it. The only problem is the huge exercise brokerage comsec charges.

Sails, please correct me on this if it isn’t right.


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## jackson8 (17 November 2008)

cutz said:


> Hello again,
> 
> If you’re buying a put as a purely protective position I guess liquidity at expiry is not much of an issue. If the option is in the money at expiry you can always exercise the contract rather than close it. The only problem is the huge exercise brokerage comsec charges.
> 
> Sails, please correct me on this if it isn’t right.




have read mention of comsec excesive brokerage on other threads . have never been ex on any of my writes as yet so cant speak from experience but have spoken to support desk and been told it is just standard brokerage costs, same as buying or selling any other stock.
would be interested if someone could expand the issue

or is it just that overall comsec brokerage costs are higher than other brokers


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## sails (17 November 2008)

cutz said:


> Hello again,
> 
> If you’re buying a put as a purely protective position I guess liquidity at expiry is not much of an issue. If the option is in the money at expiry you can always exercise the contract rather than close it. The only problem is the huge exercise brokerage comsec charges.
> 
> Sails, please correct me on this if it isn’t right.




Yes, Cutz that is right   However, long options normally give a limited risk position - we can only lose the cost of that option.  However, if that long option is exercised, we take on overnight risk.  It is no longer a limited risk position until it is closed the next day.  

One way around this is to close the position the day before.  Eg. if you are long puts and wish to exercise them which would have you short shares in your account the next morning.  It could be worth asking the broker if they would allow you to buy the shares the day before matching the quantity of the ones you are exercising.  

I found out this little gem on a US options forum.  My guess is that most Oz options brokers would baulk at this method of closing the position if there were insufficient funds in the account to make the initial purchase even though the position would be technically closed the same day of the put exercise.  But then with Commsec exercise fees, it may be cheaper just to pay the extra slippage and close the option.

When deciding between exercise vs. closing out the option position/s, I work out the cost of fees per contract.  Then place my closing order initially better than the cost of exercising and will tick it only to that same level.  If it doesn't close the option, then I am no worse off to exercise.  Hope that makes sense! 

Another thing to watch: Some brokers charge "fail" fees when the option exercise/assignment results in the buying of shares because the sale or purchase of the underlying is actually done on the day of exercise unless there are sufficient funds in the account to pay for it.  Even if closing out the next day, technically it is one day over the T+3.  To my knowledge OX and TD do not pass on this fee.   I believe the broker can get it waived by the ASX due to it being an option exercise, so theoretically, none of them should pass it on tp the client. This is another reason the above method of closing the position the same day as exercising your long option.

So many traps for the unwary...


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## sails (17 November 2008)

aleckara said:


> Thanks everyone.
> 
> I wasn't looking at anything particular in terms of ATM, ITM, OTM. I was only looking at out-of-the-money puts because I figured that if the spot price went to this price all the liquidity would be here and I would be able to close out (i.e trying to set up a protective positon) and the volatility premium on otm options is less. I can see the liquidity is currently at the atm price like I expect it to be. My concern is that if i buy the option I won't be able to close it out if I buy an atm option due to the lack of liquidity.




I have been buying front month puts when BHP has moved up for around 40-50c.  In most cases, they have been worth anything between $1.50-$2.00 within a few days, so if I have to pay 10c slippage, it's still a good profit and I accept that slippage is a part of life.  Obviously, I will try to get the fairest price I can (usually have to estimate IV to work it out), however sometimes someone else wants to buy giving me a better price than I can get from a MM.




> I have been thinking of getting involved in the US market for some time but haven't had the time to seriously look into it. I'm sure a forum search will highlight the good brokers available. However I don't want to get into trading formally as such and most brokers want you to do a few trades a month; if I have a view on a company or have a position I want to hedge I want the tools available to take advantage of that view.




Have a look at TOS - specialist options brokers http://www.thinkorswim.com/tos/client/index.jsp.  I have an account with them which is not used at the moment - and no inactivity fees.  Brilliant software - all free too.  And excellent customer support which is extremely valuable if you  need help.  Probably not as cheap as IB, but beats them hands down in these two areas - from my experience.

Also, you can trade BHP options in the US - just not sure if liquidity is any better than out here!


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## cuttlefish (17 November 2008)

(I'm only a beginner as well so apologies to the experienced players for my inevitable mangling of the greeks and other terminology... )

Due to the liquidity issue I generally only trade liquid series where the market maker has obligations so there is a constant spread around the money during the day and if you ask for a spread outside of that range (or put a sensible bid in) then they will provide one.  

For further otm positions the volatility will move about a bit and the MM's will definitely take advantage of volatility spikes to fleece you when you buy and volatility collapses to fleece you a second time round when you sell (and given they are likely to be the only ones giving you a price at all you can't blame them).

Splitting the spread and then moving slightly to the MM's side of it tends to work. You tend to pay closer to the edge of the spread for out of the money than near the money but at the end of the day, as sails points out, volatility and delta will affect the option price orders of magnitude more than a bit of slippage.  (and theta too of course as you get closer to expiry particularly for otm when volatility is low).

This is also one reason that if looking to take a long (i.e. 'buy to open') position after a spike in volatilty (e.g. take a delta position after a stock breaks out of a trading range) then you are often better off imo going for closer to the money positions because you will pay a lot of IV for the out of the money positions and unless the large move continues at the same strength you can often lose out even though delta goes in your desired direction, because of the collapse in volatility.

If you trade nearer the money you still pay a bit for volatility but proportionally you are getting more delta and the delta takes over more quickly.  (though of course this works both ways - so if delta goes against you then your position fades quickly - on the other hand if volatility collapses instead but delta stays neutral or slightly in you favour the position does better than a deeper otm position.)

Alternately if you are taking long put or call positions before a breakout while volatility is still low in anticipation of a breakout then the deeper otm positions would probably work better.

Even if just looking at delta plays rather than doing delta neutral plays whlie trading volatility or the other greeks its still well worth understanding how volatility vs delta works around the money vs away from the money - it will also help in setting up the hedging side of your spread if using skewed spreads to protect a delta position.

Because of the liquidity issue I've also found myself trading the front month most of the time. If I want to take a longer term view I split my capital allocation over the timeframe and roll over each month.  But its always a good idea to check the spreads further out before doing so - sometimes volatility spikes or delta reversals will get reflected differently in the front month vs the further out months.

Not sure if its just my imagination, but the MM's in different stocks seem to have different styles (this would also I guess directly relate to the fact different stocks exhibit different characteristics in terms of liquidity in the underlying stock, typical volatility levels etc.) so its worth getting a feel for the stocks you trade in because it might affect your strategies given slippage is an inevitable part of it.


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## cutz (17 November 2008)

jackson8 said:


> have read mention of comsec excesive brokerage on other threads . have never been ex on any of my writes as yet so cant speak from experience but have spoken to support desk and been told it is just standard brokerage costs, same as buying or selling any other stock.
> would be interested if someone could expand the issue
> 
> or is it just that overall comsec brokerage costs are higher than other brokers




Hi Jackson8,

Yeah,

Comsec definitely charge a higher rate on exercise/assignment brokerage, its 0.35% as opposed to 0.12% being the normal rate.


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## aleckara (18 November 2008)

cuttlefish said:


> (I'm only a beginner as well so apologies to the experienced players for my inevitable mangling of the greeks and other terminology... )
> 
> Due to the liquidity issue I generally only trade liquid series where the market maker has obligations so there is a constant spread around the money during the day and if you ask for a spread outside of that range (or put a sensible bid in) then they will provide one.
> 
> ...





This is interesting. I am not a total beginner when it comes to option positions, greeks and the like but dipping my toes into the water and actually trading them is a different matter than knowing the theory. For one thing you need to understand more intitutively and be able to have the tools to calculate quicker. Thinking of developing trading software sometime that can do this for me (when I have time). The lag between the calculation and the buying is something I have to get used to particularly with Commsec's website method of trading.

In this market I have noticed that the IV's do fluctuate depending on the whether they are itm, atm, or otm. In fact I can see IV's fluctuating between different series of options with the same asset (e.g BHP taking the last prices). Then again I didn't look at it in depth.

I'm not sure how the market makers work as such and what their obligations are. Are you saying that they only have an obligation to provide a market for in-the-money or atm options in the front month?


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