Thursday, February 25, 2016

Penny Pilot Stocks

When looking to trade options on stock, the tighter the bid-ask spread the better. This spread is an indicator of liquidity provided by market makers and an indication of a willingness to trade the option.

Stock shares on modern exchanges are very liquid, usually a penny wide in the bid-ask at any time.

Options on shares always trader wider, which means that you give up some profit on entry and exit.

For example, if a call option is trading 1.10 by 1.20 -- this means that you will pay 1.20 to buy and 1.10 to sell. So, if you could buy and sell it instantaneously, you automatically lose 0.10 because of the spread (and any commissions).

0.10 as a percentage of the option price is 8.33% (0.10 / 1.20 = 8.33%). This why you would use a limit order at the mid price of the option. Offer to buy or sell at 1.15. With a limit order you make up half the spread and cut your slippage to 4.15%

What we want to do when trading is always look for options that trade as tight as possible, pennies wide between the bid and ask. A net 1% to 2% compared to the underlying price is very realistic.

In the last few years, the CBOE (Chicago Board Options Exchange) started a program to decrease the spreads in many high volume stocks. This is called the Penny Pilot.

A downloadable list of the stocks in this program from the CBOE is available from here as a spreadsheet file (choose the top link called Penny Pilot classes).

With a tool like OptionsAnalysis you can paste in this list of 350+ stocks and further runs scans on them such as high IV ranking, moving average crossovers, to find candidates and trends which you may want to establish positions on.

The Penny Pilot stocks are essentially pre-filtered and aim to provide much better liquidity in the market for traders. The CBOE and other exchanges encourage this because the higher the trading volume the more the exchanges themselves profit. It also benefits the retail trader by allowing easier and fairer entries and exits.

Here is a video below that demonstrates how I add this list into OA.

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