The first, and most important step in options trading, is to
create a watchlist of highly-liquid, optionable stocks or
. This will be the foundation of your all your trading endeavors.
The reason you MUST only use highly-liquid stocks or ETFs is so
that you can rely on pricing efficiency.
The more liquid the option the tighter the bid/ask spread.
This is extremely important because the bid/ask spread impacts
the cost of using options. Wide bid/ask spreads eat into the
potential profitability of your investment, and contribute to
what is known as 'slippage'.
The easiest way to search for what I call 'tradeable' options
on ETFs or stocks -
. I look for ETFs with an average volume over 1 million shares
traded is because I want liquid options. Sometimes the 1 million
may not be enough, but it is certainly a good starting point.
Again, liquidity directly translates into a reasonable bid/ask
spread for options -
this is critical.
It allows you to trade in and out with giving up much of an
Sometimes, I receive emails asking me to look at a small-cap
or penny stock with 50,000 shares traded. For one, most, if any,
offer options. Remember, we use a probability-driven approach
using various credit spreads in the Options Advantage service.
This would be impossible to do with illiquid underlyings.
Lack of volume is the main reason that I do not use individual
stocks in my strategies. Most stocks do not offer liquid options.
And the ones that do are subject to volatile moves due to
unforeseen announcements, earnings surprises, etc. There is no
need to take on this type of risk knowing that I can make
consistent gains using highly-liquid ETF options.
Also, by limiting the number of underlying stocks or ETFs, you
have the ability to focus and become familiar with a select group
that will aid in making your trade assumptions. Creating this
watchlist will save you lots of time. You'll thank me later.
For my Options Advantage service I follow and provide roughly
40 highly-liquid ETFs that include SPY, IWM, DIA, QQQ….some of
the most liquid options in the marketplace. I also provide
subscribers within my weekly report the overbought/oversold
levels of each.