The Importance of Liquidity When Trading Options - YouTube

Hey everyone.

This is Kirk, here again from optionalpha.com.

In this video, I want to talk again just about the importance of having liquid options that

are tradable for your portfolio and for your system that you're creating in your trading

plan.

I learned this lesson the hard way in December of 2014 because I had made a trade in A&F

which is Abercrombie & Fitch and we were trading this stock around earnings.

We made a nice iron condor trade on A&F and everything was going good and as we got closer

to expiration, I wanted to close the position, but what I found was that the liquidity or

lack thereof of liquidity in the market was so low that no matter what price I put in,

I could not get filled.

I want to go through some of those orders here today just to show you how many orders

we tried to place.

In fact, I even tried to overpay for getting out of the trade, deliberately putting myself

in a bad situation just to see if the market would fill that order.

And because there was just nobody on the other side of the trade, it was a trade that I had

to let go all the way to expiration and thankfully it was a profitable trade, but it could've

gone completely against me and I would not have been able to get out of the trade.

It proves the point of having high liquidity and very active securities that you need to

be trading in your portfolio.

On the screen here is my Thinkorswim platform and I went back 300 days from that date just

looking at all the different trades that we made in A&F.

You can see as I scroll down here that our only fill and order history was the actual

entry of the trade.

You can see that opening trade to close and this is going back 300 days.

This encompasses everything.

I’m not hiding anything and trying to say that I didn’t get filled.

No.

I only got filled on just the opening orders to get into this security and that was on

11/7.

That’s when we got filled on the security which is 11/7.

What you can also see is that we tried to get out of this trade on 12/4, 12/3, 12/4

again, 12/3, 12/3, 12/3.

On a couple of days we were trying to get out of this trade, we just could not possibly

exit the trade.

You can see because on right hand side of the screen here, you can see that these orders

expired or were cancelled and replaced by other orders because they just wouldn't fill.

In fact, at some point during the day, we actually entered a trade to get out at an

$.8 debit and when the market was trading around $.6 or $.5 to close out the position,

you can see a lot of the prices that we’re going for is about $.6, $.5, $.4 at one point,

we tried.

But at one point during the day, we actually tried to get out of the trade just saying,

“Hey, we’re going to overpay to get out of this security, hoping that somebody would

come in and release us from the trade and bank our profit.”

But even in fact, trying to overpay for the market with just nobody there, didn't end

up closing out the trade.

This just really goes to show you that if you want to create a very profitable business

around trading and making high probability trades, a requirement of doing that has to

be liquid options because you can get into a great trade like we did in Abercrombie & Fitch,

in A&F.

We got into a great trade, it ended up being a profitable trade, but had we need to make

an adjustment or close a position, we just could not close the position because nobody

was there.

This really proves the point and hopefully you know now that you have to stick to high

probability trades.

We do publish our own watch list of prescreened and pre-scrubbed securities that have highly

liquid tradable options and you can get that from optionalpha.com inside the membership

area.

If you guys have any questions on liquidity, please post them right below.

If you want me to check out a stock that you don't know, if it has good enough liquidity,

put the ticker symbol on the comments below this video and I’d be happy to take a look

at that stock and let you know my thoughts on if it needs the liquidity requirements

that we have.