Take Liquidity into Account in your Trading Decisions
Jim Graham

Investors require market liquidity. A market is said to be liquid if transactions can be executed quickly and easily. A trader should know the liquidity of the market that he is trading or wants to trade, and use that information when making trading decisions. On options exchanges, both Volume and Open Interest provide a good indication of market liquidity. The higher they are, the more liquid the asset. 
 
Volume is a number that tells you the number of contracts traded that day, just as the volume on a stock exchange tells you how many shares of stock have traded. The big difference between a stock and options exchange is that no security is "created" by the act of trading on the stock exchange. People simply trade the securities available back and forth. On an option exchange, however, an option can be created by the simple act of placing a trade. Before an option is traded, it simply does not exist. Open Interest tells you how many contracts are outstanding for each asset and in each individual option. 
 
How can you take liquidity into account with your everyday trading? The most obvious way is to use the volume, average volume, and open interest figures that are available for every option. If you are considering a trade, seeing volume that tiny or non-existent means you probably won’t be able to trade very many contracts at the currently quoted price. Worse, it may indicate that the position could be difficult to get out of if things move against you.
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