Abstract:
In this paper we will discuss the importance of option liquidity at the time of option trading. The traders ought not to buy an illiquid stock option to avoid the losses.
At the time of options trading, the measurement option liquidity is done on the basis of the fact that how quickly the maker of the market traders with one option trader in the absence of another.
Stock option liquidity is an important aspect of option trading. The traders should not purchase the illiquid option contracts.
Most of the traders think that option liquidity is not measured by calculating open interest, which is not correct. By using the stock volume an options trader can measure the liquidity efficiently, although it is not the best method of liquidity measurement since some options may be very liquid if their volume gets lower by a large amount.
When a stock option is quoted, the contract name, ask, open interest, last price, volume, bid is included with it. Open interest shows the number of open contracts that are still floating for a certain option contract.
Each option contract starts with no open interest. When a trader buys the option contracts, then the open interest rises. Therefore, no open interest, or zero open interest, does not mean that the option is fully liquid.
To increase their profit an option trader should examine the liquidity of an option contract before going for it. The market makers will obviously narrow the bid-ask spread down if the option contract is too liquid.
