Slippage on longer dated positions

[Mofra]

Howdy,

This is a question directed more to people who trade the Aussie market, knowing liquidity is less of a problem in the US.
Just wondering how people factor slippage into a longer dated leg of a trade ie a calender spread? No doubt you'd have to sell nearer the bid if you were to exit the position, and often have to bid closer to the ask to open a possie.

Is it just a matter of adding a tick or two in the payoff diagrams, rolling back the size of the position, slightly ratio-ing (if that's a word) a position or a combination?

Cheers

 

[sails]

Howdy,

This is a question directed more to people who trade the Aussie market, knowing liquidity is less of a problem in the US.
Just wondering how people factor slippage into a longer dated leg of a trade ie a calender spread? No doubt you'd have to sell nearer the bid if you were to exit the position, and often have to bid closer to the ask to open a possie.

Is it just a matter of adding a tick or two in the payoff diagrams, rolling back the size of the position, slightly ratio-ing (if that's a word) a position or a combination?

Cheers

Hi Mofra,

Agree that slippage is an expensive cost to options trading. Based on 10 contracts, every 1c of slippage will cost $100. So if we do 10 trades x 10 contracts and lose an average of 2c slippage on each trade, the total cost of slippage would be $2000 If full service brokers could definately guarantee less slippage, it might be worth their fees, however, this has not been my experience so far.

In an effort to contain slippage, I stick with the most liquid options and make sure that there is good liquidity and a tight bid/ask spread in the underlying share when entering a trade. It's possible that it may make it easier for MM's to get a hedge on at a better price - hopefully resulting in a slightly better fill for me - resulting in an acceptable deal for both of us. But then, I don't know much about market making, so could be completely wrong!

Also, usually find it's easier to get closer to the mid price when placing spread or combo orders (including "rolling") vs. trading each leg separately, however, sometimes it works well, but not consistently.

I use actual traded prices for risk graphs of live trades, so slippage is already factored in. If testing out strategies, I usually adjust prices in the risk graph to reflect buying nearer the ask and selling nearer the offer.

Perhaps Magdoran or Spitrader1 might have some comments to add as they are both familiar with the Aussie options market.

Cheers

 

[Magdoran]

Howdy,

This is a question directed more to people who trade the Aussie market, knowing liquidity is less of a problem in the US.
Just wondering how people factor slippage into a longer dated leg of a trade ie a calender spread? No doubt you'd have to sell nearer the bid if you were to exit the position, and often have to bid closer to the ask to open a possie.

Is it just a matter of adding a tick or two in the payoff diagrams, rolling back the size of the position, slightly ratio-ing (if that's a word) a position or a combination?

Cheers

Hello Mofra,


I did read your question when you posted it, but have been really busy – lots of action on the market right now, isn’t there? Hello Margaret, thanks for making a comment while I was immersed in things…

Now, Mofra, I only have a time for a very cursory answer to a very involved subject.

Key variables are timeframe, strategy (directional vs non directional), market conditions, position size, trading/investment style, risk tolerance, objectives etc.

Slippage is a part of doing business in my view. I trade a range of strategies to suit the situation, but at the core I trade aggressive directional plays in Australia, mainly single series OTM positions that I then position hedges around them, and on counter trends (often ratio diagonals, back spreads, sometimes full counter trend plays).

For me, interestingly the best profits I have made are in not very liquid options, with low open interest, and large spreads. This is because I look for specific technical patterns based on time and price. I see the slippage on the way in and out as a cost of doing business on top of the brokerage.

Hence a lot depends on what you are doing. Considerations are risk to reward, underpinned by probability of success. In simple terms, how likely is the strategy to succeed, and what is both the maximum risk to reward, and what is the most likely risk to reward (there is more to this of course).

The problem with the US is not as obvious, but the gradation of strikes is $2.5 gaps for small stocks, and $5 for larger stocks, where here there is much finer gradation, which actually makes a huge difference to the profit potential and the risks - and the price increments are in 5 cent blocks as opposed to half cent increments here (much, much better here if you know what you are doing). I believe they are trialling 1 cent increments on a handful of DOW stocks, and this would be a welcome change.

The problem is exiting in the US is that you have to move a whole 5 cents in the increment as opposed to a half cent. Big difference if your entry was 10 cents for example, believe me. Guaranteed 50-100% loss if it goes wrong. Here you may suffer only 30-40% loss for instance just because of the gradation. This is less true of course for larger amounts, but you still have to move 5 cents.

This 5 cent increment problem in the US really hurts you on the way in and on the way out. Hence, on balance, I think the lack of liquidity in Australia is the trade off for the finer gradation in the strikes here, which for my style is way more important than the liquidity in the US because there is significantly less choice (maybe one strike deep in the money, and one way out of the money).

In reality where I can pull off a 300-500% return in Australia, the same trade in the US may only yield 150%- 200%. Big, big difference. Also, the risk is higher too in terms of percentage loss because the increments tend to work against you as well. Sure, they’re more liquid over there, but your exposure and the increments kill you. I tried to crack the US market for some years, and all my primary directional tactics that work here, met with mixed success over there, so much so I gave up trying to trade directionally in the US (plus I like my sleep).

As for calendar spreads, I’m not a big fan of them in a trending market – too little reward for the risk in my view. These work well in flat or mildly trending markets. That’s not here or in the US at present now is it? You can use this tactic if you can find flat stocks, and if that is your preference, then you do need to factor slippage and volatility into the equation. You want more volatility in the front month sold strike, and less in the back month bought strike. But I don’t think this is a good strategy to use on a strongly trending stock…


Hope that helps for now Mofra…


Regards,


Magdoran

 

[Mofra]

In an effort to contain slippage, I stick with the most liquid options and make sure that there is good liquidity and a tight bid/ask spread in the underlying share when entering a trade. It's possible that it may make it easier for MM's to get a hedge on at a better price - hopefully resulting in a slightly better fill for me - resulting in an acceptable deal for both of us. But then, I don't know much about market making, so could be completely wrong!

Thank Sails,
Yes the "liquidity lament" is something I'm sure I'm not on my Pat Malone about - more often on verticals even a couple of strikes from the money.

Also, usually find it's easier to get closer to the mid price when placing spread or combo orders (including "rolling") vs. trading each leg separately, however, sometimes it works well, but not consistently.

Food for thought, I generally leg into my spread via a reasonably aggressive short side ask first, and wait to see how the course of trades pan out before completing the position.

Appreciate the reply, cheers.

 

[Mofra]

Slippage is a part of doing business in my view. I trade a range of strategies to suit the situation, but at the core I trade aggressive directional plays in Australia, mainly single series OTM positions that I then position hedges around them, and on counter trends (often ratio diagonals, back spreads, sometimes full counter trend plays).

Absolutely agree with the cost of doing business, of course like any business it is worth the time to keep investigating a way to cut costs

For me, interestingly the best profits I have made are in not very liquid options, with low open interest, and large spreads. This is because I look for specific technical patterns based on time and price. I see the slippage on the way in and out as a cost of doing business on top of the brokerage.

You've basically nailed the reason I asked the question in the first place - assuming a trade price of roughly the mid-point of the spread, there appear to be some real exploitable oppotunities in the less liquid series. Having some time off, I recently had more time to explore the less liquid series in detail.

Now, Mofra, I only have a time for a very cursory answer to a very involved subject.

I found your reply more than cursory, appreciate your time,

Many thanks