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Monday, February 25th 2019

Last Week Volatility Cost Options Traders Over a Billion in Slippage.

Last week was rough for options traders. Here's the methology we used to help prevent high volatility from impacting us too greatly.

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Summary

Last week's high volatility and increased volume in the options market caused market width to double and size on the bid and offer to decrease, costing traders over a billion in additional slippage costs. The lack of market makers was identified as a reason for this. The methodology used to study this is also explained.

If you found option trading challenging last week, you were not alone. We have heard complaints from our clients about wide markets and low liquidity. Here are the numbers and why.

With the volatility and increased volume last week, options market width doubled and size on the bid and offer was off nearly 1/3 of the previous week, costing option traders over a billion in additional slippage costs.

Slippage, or the cost to trade, is the trade price minus mid-market times volume. A typical day last week total slippage was $163 million. Monday, February 5th slippage was $555 million. After the week was through, options traders paid over a billion more than normal in slippage.

1. The ask-bid / option price went from 8.2% average for the week before to 16.6% on 2/5 (more than doubled!).2. The displayed size on the bid and ask went from 138 average for the week before to 100 on 2/5.3. The displayed size is already anemic now compared to the recent past. The past three years averaged 366 size on the bid ask for 2015, 2016 and 2017, taken the same time in early February in those years, and was 138 last week and 100 on 2/5.

One reason for this is the lack of Market Makers.

From Alan Grigoletto "The data, technology, regulatory, capital and clearing costs make it nearly impossible to enter as a liquidity provider.

What most don't understand is that Market Makers need other Market Makers to lay off their risk. Only a handful of ETFs and large names have any real option liquidity even when vol is subdued. 15 venues and 5 true market makers is a lousy ratio."

Methodology and terms:

We look at one snapshot for each day of the entire market before the close. We filter out options with no bid, no volume and very expensive options >$1000. Slippage is (ask price - bid price) times volume times the slippage ratio. The slippage ratio used is .25 which was studied in the surrounding days (contact me directly for the methodology).

Disclaimer:

The opinions and ideas presented herein are for informational and educational purposes only and should not be construed to represent trading or investment advice tailored to your investment objectives. You should not rely solely on any content herein and we strongly encourage you to discuss any trades or investments with your broker or investment adviser, prior to execution. None of the information contained herein constitutes a recommendation that any particular security, portfolio, transaction, or investment strategy is suitable for any specific person. Option trading and investing involves risk and is not suitable for all investors.

All opinions are based upon information and systems considered reliable, but we do not warrant the completeness or accuracy, and such information should not be relied upon as such. We are under no obligation to update or correct any information herein. All statements and opinions are subject to change without notice.

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Be sure to read the OCCs Characteristics and Risks of Standardized Options to learn more about options trading.

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The opinions and ideas presented herein are for informational and educational purposes only and should not be construed to represent trading or investment advice tailored to your investment objectives. You should not rely solely on any content herein and we strongly encourage you to discuss any trades or investments with your broker or investment adviser, prior to execution. None of the information contained herein constitutes a recommendation that any particular security, portfolio, transaction, or investment strategy is suitable for any specific person. Option trading and investing involves risk and is not suitable for all investors. For more information please see our disclaimer.
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