Options offer tremendous leverage opportunities to play high-priced stocks or very active, liquid securities. Options are not only offered on equities but indices, futures, and commodities. Market-makers use options as easy hedging vehicles, but that only works best when there is good open interest.
This brings me to the issue of liquidity. These days, it seems there are a limited amount of participants who even want to venture into the realm of option market-makers. We’re not talking about your highly liquid names like FB, MSFT, INTC, AAPL; rather, the off-beat names that have good price action yet lack the punch of good volume are what we want. Note, the two most important indicators are price and volume. Some stocks just have so little volatility that the options market is completely ignored. When that happens, the spreads create an impossible entry point.
The main issue is this: Am I able to get in/out at a fair price, or am I being taken for a ride?
Take a look at a name like Priceline (PCLN). A four-digit stock that trades well under the float has stock clearly held by institutions and insiders. They don’t care about the options market. The poor open interest in the name across all strikes is evidence of that. The November 1150 monthly strike has about 850, which is the highest amount. All other strikes are far lower. These prices are all high and pretty much freeze out any buyers.
But let’s take a look at another name, Red Robin (RRGB). The chart was looking good the other day before earnings, but, looking at the open interest, the highest level was the 60 strike, which had less than 300. The stock trades well under 1-million shares a day but the lack of interest causes the spreads to be wider than a semi-truck. So, I just had to pass, even if the chart is strong.
After earnings came out on Tuesday, it appeared Red Robin was ready for a bigger move. I looked at it when the stock was up 6, it went up further at the end of the day, and, on Wednesday, the stock pushed up 4%, yet the options provided little edge to an entry or exit (the Nov 60 call finished Wed with a bid/ask spread of 5.2 x 7.90 – horrid!). The market makers are egregious, but it’s really about not letting you in the game. This is symptomatic of many names out there.
So, with little liquidity in names there is less volume, yet we see the biggest market maker, CBOE making new highs day after day. Where is the liquidity? I see it in weekly options, the newest product and the most used of late. Further, the VIX options and index options see quite a bit of daily activity, but for the “little guy,” it becomes incredibly hard to participate.
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