I received a question from an All Star Options customer this week about best practices when trading options that don’t have much trading volume, have very low open interest, and/or wide bid/ask spreads.
I thought this was a great question, and I’m sure there are many traders who could benefit from some instruction on this topic.
First and foremost, trading illiquid options is tricky and something I try to avoid. I don’t need the headache.
But when I do trade an illiquid option, I’ll only be a buyer. I will not be naked short in an illiquid market. This is the only way I can control my risk, because the most I can lose is the premium I paid. And I will rarely, if ever, attempt to enter any type of multi-leg spread order. It’s simply too many moving parts that would reduce my already slim chances of getting a fair fill.
I will patiently work an entry to buy with a limit order that is a new best bid. And I’ll keep improving that bid if somebody raises it on me. I definitely won’t chase an entry here. There is a certain level of zen acceptance required here to wait on the bid.
I will go into this trade knowing full well that if it doesn’t work, I’ll likely suffer a 100% loss of the premium paid. That’s just the cost of doing business.