Stocks and Commodities Magazine

Helpful Hints When Determining Commodity Markets to Trade and Not Trade Based on Liquidity

It seems like commodity option liquidity is hit and miss. Give me some tips on markets to avoid, those I should focus on, and tips to navigating them appropriate to the liquidity they provide.

I tend to be an advocate of trading options. Whether the strategy is to buy and sell options to hedge futures positions, or to trade options and option spreads outright, it is almost always a more conservative approach than simply taking a position in a futures contract. This is because option trading has the potential to offer traders more room for error. I don’t know about you, but I need all the leeway I can get!

With that said, not all option markets are viable contenders for speculation. Some involve challenges that green traders might not recognize until it is too late. Further, even if they are aware of the obstacles, they might not necessarily know how to effectively manage them. Here are a few tips and tricks to speculating in commodity options.

Stick to liquidity and monitor bid/ask spreads
Gauging a commodity market for ample liquidity isn’t quite as simple as looking at daily volume and open interest stats, but that is a good start. Ideally, you don’t want to be trading an option if you will be the majority of the open interest (the number of contracts outstanding). In illiquid option markets, there is a high probability that you will have difficulty exiting the position at a “fair” price. Thus, ideally, you will want to see active daily volume and hundreds of contracts tallied in the open interest column.

 

More on the helpfulness of liquidity when determining option markets to trade in the January 2015 issue of Stocks & Commodities Magazine

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