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Sometimes even a diehard options trader has to buy the stock instead of the option. In some cases having an option that trades on a stock is just worthless baggage for the investor. But for every trade you want to check on the market volume and liquidity. Let me give you an example (Rest assured, this is NOT a buy recommendation) Stocks With Market Volume Are A Trader\'s Delight.
There is a little company out there called Immersion. It trades about 200,000 shares a day and is in the midst of a major trial with Sony. If the trial goes Immersion\'s way, investors in Immersion will profit handsomely. If not, they will lose their shirts in the short-term. It is that big of a deal. Immersion stock is a trader\'s delight. But it also has options and they aren\'t. The problem is that the market for Immersion\'s options is very thin. How thin? The options rarely bid or offer more than 10 contracts a day and that\'s when there is some volume. And each time there is a trade, the option price moves. That\'s what you can expect in a supply and demand world. With short supplies, every demand gets jerked around. As a result of its thin trading, the options are expensive and have very wide spreads. These are further indicators that the options market makers will make you pay to play the long and short side.
Immersion\'s options have limited value to anyone. If you are a small investor, you might be able to trade a few options here or there and come out OK as long as you timed your entry perfectly and the shares moved so much that the option had to pay off even after the spread, the market maker\'s shenanigans and commissions. That\'s a very long shot. In fact, it\'s too long a shot In a case like this, options do not matter the investor is better off buying the shares.
When Buying an Option, Check the Liquidity So the lesson here is pretty straightforward: When you are considering buying an option, always look at the liquidity. If the option only trades on one or two exchanges, or has fewer than 50 contracts on the bid or offer across the chain (that is : all the months and strike prices available) for the day, then you are looking at a situation with low liquidity, and you may want to consider avoiding the option altogether. If the stock moved opposite to the direction you were counting on, the options market maker may make you pay dearly to get out of the position. In a thinly traded option, the market maker has a lot of room to finagle prices and worse, he needs to make a lot of money on us since he has so few birds to pick.
Check Your Hot Ideas for Market Volume Before Investing If you subscribe to an options service, it is very unlikely your advisor will put you into a trade like Immersion options. But it is exactly the kind of trade people make when they\'ve traded a few options with someone else and gained a bit of confidence - enough to try out their own "hot idea." You\'ll come across a stock that interests you, usually one of your own "penny stocks" or micro-caps, and see a way to turn a would-be 25% price explosion into a 200% options gain. In fact, these kinds of hot ideas can be especially lucrative if you know the stock well. But usually, the option volume is too thin. If you want to start trading some of your own ideas, it\'s still better to stay with heavily traded stocks at the beginning. You may not win, but at least you will have a fair chance. With thinly traded options, your chances are thin, indeed.
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