I’ll be honest. It could be dry and boring. I’m going to give you just straight up the information.
If you trade options that do not have enough liquidity, you can have a high profit on paper, but not in reality.
Does that confuse you? Let’s start from the beginning...
An option is nothing more than the right to buy shares of a company at a fixed price. You have the ‘option’ (hence the term) to buy the shares for the price specified in the contract. The same is true, by the way, when you buy commodity options.
So… that’s understood. Now, let’s go back to the original question.
If you buy an option contract that will make you a lot of profit in the end, you may want to sell that option before it expires. That’s how many options traders do their business.
They want to get out of the trade while they are up and before the option contract expires. This is because there is a possibility that the option value will fall back to zero.
But where is the catch?
So, if you own an option contract that has gone up in value, you probably want to sell while you’re up. But what happens if no one wants to buy? Means – no liquidity.
What happens if you own a contract that gives you the right of thousands of dollars, but no one wants to buy your contract?
I will tell you what happens…
You will not get your money!
To put it in a nutshell
Suppose someone gives you a brand-new Porsche at a generous discount. The car is worth $150,000. The person who gave you the Porsche says, “You have to sell this Porsche in one week. You can keep all the money you earn from the sale, but you must sell it within a week. But if you haven’t sold the car by the end of the week, I’m going to scrap it and you won’t be able to sell anything.”
So you’re desperately trying to sell this Porsche. You think incessantly: Who are my rich friends? Who wants to buy a Porsche?
Your mind is going crazy. You have no buyers! You have no liquidity!
Ok… You got it.
There are so many more developments to come in the near future. This will cause massive volatility in a variety of markets. And that means great opportunities for us!
I address this topic for a specific reason. I believe that in the near future there will be many extremely profitable deals that will bring huge profits for you and me.
We can leverage our profits by trading options (more on that in future posts), so we can make a lot of money. But we can also get trapped in trades if we get too greedy. We have to be careful of that.
We need to keep an eye on options spreads (the differences between the bid and the ask prices).
That’s it for today. Just don’t get bogged down in a trade!