"Liquidity Concerns About Selling Options?"

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"Liquidity Concerns About Selling Options?"

"Hello. I am just starting option trading and wondering if someone has to buy my options if I decide to sell versus exercising. Regardless how early or late to the expiration date? I notice sometimes there are no volume for some strike prices and was wondering if it was like a stock where it may not execute if the price isn't right."
- Asked By Cprast on 10 June 2011

Answered by Mr. OppiE

Hi Cprast,

Welcome to the world of options trading! Indeed, options trading can be confusing without thorough knowledge of the technicalities behind how options are created and the system by which they are traded. The worst thing about options trading is that these confusion typically occur quite suddenly and unexpectedly and only after some options positions are bought; how to close them out, what happens when they are exercised, liquidity issues etc. As such, I am glad you are seeking professional help here at www.Optiontradingpedia.com.

From your question above, it seems like you have not one but several questions that must be answered; What happens when you exercise an option, are you able to sell prior to expiration and how to determine liquidity of options contracts. Lets answer them one by one.

When you buy an American Style Option, which all stock options traded in the US market are, you are able to exercise your option anytime you want prior to expiration. However, if you buy an European Style Option, your options will only be automatically exercised upon expiration, no exercise would be possible prior to expiration. Learn how to tell if an option is European Style.

When an American Style Option is exercised before expiration, it goes through a process known as "Assignment" or "Random Assignment". This means that the exchange will simply select at random an options trader account holder with an equivalent amount of short options that you are exercising. If you exercised 1 contract of call options, someone who wrote 1 contract of call options would be randomly selected to sell you the stocks covered by the call options. If you exercised 1 contract of put options, someone who wrote 1 contract of put options would be randomly selected to buy your stocks at the strike price of those put options. This process is completely random and there is no risk of default on the part of the short due to the fact that the broker would have made sure a person has the cash margin or stock position to fulfill his or her part of the deal before allowing them to write options in the first place. Yes, if you would like to write options, you would need to fulfill certain margin requirements before you are allowed to do so. This ensures that if your options are exercised, you are able to fulfill your obligations under the terms of the options contracts you wrote.

All options, whether American style options or European style options, can be bought or sold anytime prior to expiration. Also, You don't have to exercise an option in order to take profit, all you have to do is to sell your option at the higher price that it is now will do. In fact, you can be selling your options 5 mins before expiration and it will be sold as long as sold at the bid price. This is due to the fact that in options trading, you are not really trading with other options traders like yourself but with a professional "Market Maker". Market makers are professionals in the exchange who are responsible for ensuring a market for all outstanding options. Learn more about Market Makers.

You tell the liquidity of a stock primarily through its daily volume but this is quite different in options trading. In options trading, an options contract can have completely 0 volume and still be very liquid in that you are always able to buy at the ask and sell at the bid quite instantly. In fact, most options contracts that are out of the money or not of the nearest expiration month would typically have zero volume. This is due to the fact that the liquidity of options contracts depend more on the willingness of the market makers to make a market for that contract! When market makers are actively making a market for a certain options contract, they will compete for better bid and ask price, resulting in a tight bid ask spread. Yes, options of low liquidity would have an extremely wide bid ask spread. But no matter what, as long as you are buying at the ask and selling at the bid, you will always be able to buy or sell an option regardless of the apparent liquidity condition. This is because the bid and ask price of options are put up by market makers who are ready to trade that option at those prices. Of course, the best options would have a tight bid ask spread, high volume and high open interest, like options on the QQQ. However, if you are looking at options with no volume, do not be afraid, as long as the bid ask spread is tight enough (anything within $0.20 is very good) and there are a lot more open interest than the number of contracts you intend to buy, you are quite safe. Learn more about Volume and Open Interest.


In conclusion, when trading stock options in the US public market, you will be able to sell your options at anytime you want to and always be able to buy and sell your options at the bid and ask price listed in the options chains.