Discussion of Options
Preference for more open interest and more volume
Typically if one wants to trade options, one gets the more efficient prices from the more efficient market.
Efficiency usually involves "the more participants the better the prices whether buying or selling an item".
You want to see higher volume and greater open interest. In addition to efficiency, if one wants to take
advantage of a price movement in a stock, one prefers a higher delta.
Let us provide an example. I write this on December 11, 2010 and I am choosing American Capital Agency
Corporation stock and its options for my example. (AGNC OTC).
In order to get higher volume, one typically gravitates toward the strike prices closer to the current trading
price. Also, the experienced trader has noticed that the front month (the option date that is closest to
expiration) will typically have the greatest volume. These higher volumes will tyically yield the more
efficient prices and also the highest delta. By "highest delta" one means the greatest movement in the price
of the options for a given movement in the price of the stock. If one anticipates a predicted price movement,
one wants to have the highest delta possible.
Perhaps the best illustration of this is the activity we might engage in if we had not even read a book on
options and therefore might do the opposite of what we are advising here. Let us say that when we
anticipate a change in AGNC stock price but instead of choosing the closest date (in this case DEC) we
choose a date 7 months out (in this case, that would be JUN 2011). Let us also specify that we choose a
deep in the money strike price for the options we wishe to trade. In this example, we prefer the $26 strike
price which is a deep in the money strike price and will give us a lower delta.
If you examine the various Call Options available for JUN 2011, you see that the deep in the money and far
out of the money options qualify for the smallest open interest and volume. See chart 1 below. If you look
at the second chart, you will observe that given our desired $26 strike price, the Calls in the month of June
are the lowest by almost an order of magnitude (70 vs 502).
The following chart shows the low volume of the June 26 Calls:
The following chart contains the Greeks with parameters that were the best that I could come up with. The
main point is that the stock is not acting in a Black-Scholes manner as discussed in the previous screen.