Who Said it Best: Liquidity (Part 1 of 5)

At dough and tastytrade, we have researched and adopted a set of trade entry criteria that govern where and how we trade. If you have watched our video segments before, you have probably seen these terms brought up:

  1. Liquidity
  2. Implied volatility rank (IVR)
  3. Selling premium
  4. Probability of profit (POP)
  5. Managing winners

In this “Who Said it Best” post, I go over the first topic on the list: liquidity. Pulling no punches and with completely biased judging, I breakdown the best (a.k.a. my favorite) videos explaining what liquidity is and how to incorporate it into trade decisions. Friendly competition rarely hurts anyone and if you happen to disagree with my rankings, feel free to pick your own favorite videos and post them in the comments!

Let the countdown begin!

3. Tom & TP

Getting started at number three is Tom Sosnoff and Tom ‘TP’ Preston with a segment from “Best Practices.”

The focus of the video is understanding how to identify liquid underlyings and strike prices, why we trade liquid underlyings, and practical applications of how they go about trading. An overarching theme that we will see in all of the liquidity videos in this list is the importance of the three main liquidity metrics:

  1. Bid/ask spread
  2. Volume (stock and option)
  3. Open interest

Tom and TP emphasize that trading liquid underlyings and strike prices provides more opportunity, as it limits losses to the bid/ask spread.

For instance, if two underlyings have equal chances of profit and loss, the more liquid underlying will provide a better trading opportunity, because we can enter and exit the trade at more fair prices. A wide bid/ask spread in illiquid underlyings acts as an extra access fee that we do not have to pay in more liquid underlyings.

Instead of having to constantly analyze the liquidity of underlyings, Tom and TP place the majority of their trades in familiar underlyings that they already know are liquid. Trade creation for TP happens by first looking at his list of liquid underlyings, and then choosing a premium amount, probability, and strategy type.

Liquidity trumps all.
— TP

2. Ryan Grace and Mike ‘Beef’ Hart  

Ryan and Beef have a huge archive of videos breaking down and explaining trading concepts. If you ever have a question on a specific topic, click the “FIND SHOWS” button at the top of tastytrade (pictured below) to check out their entire archive.


Ryan and Beef begin discussing liquidity by defining it as “the ability to get in and out of something with ease and with little transaction cost.”

They then walk through each of the three liquidity metrics inside dough.

The first thing they look at is the bid/ask spread in the SPY (ticker symbol for the S&P 500). The bid/ask spread is the difference between what we can buy something for (the ask price) and what we can sell something for (the bid price). A tight bid/ask spread means using current prices we can get in and out of a trade without losing too much to the spread. Next, Ryan and Beef look at option volume and open interest to gauge market depth in an option chain and at individual strike prices.

A tight bid/ask spread does not necessarily mean an underlying is liquid or will stay liquid. Option volume and open interest help us measure the level of activity in an underlying to estimate whether the market will remain liquid. We generally look for open interest around 1,000 and option volume around 1,000.

1. Mike Butler

“Mike and his Whiteboard,” is my go-to options trading show to understand basic trading concepts, like liquidity, and any other trading topic. Mike visually explains concepts using whiteboard-esque slides filled with helpful pictures and diagrams.

And the Winner Is...

I picked “Mike and His Whiteboard” as my number 1 segment, because each show focuses solely on a specific topic allowing Mike to cover it in more depth (and Mike has a great collection of button-downs). “Mike and His Whiteboard” splits liquidity into two shows: the first show on volume and open interest and the second on bid/ask spreads.


Mike begins by explaining volume and open interest each with their own slide and then he talks through a trading example counting both as four consecutive trades are made (pictured to the right).

Generally, high volume and high open interest mean there is significant market participation, as trades are being opened and closed. Remember that for a trade to occur and create volume, the bid and ask prices (set by a buyer and seller) must agree or overlap. The more volume at a strike price, the tighter we assume the bid/ask spread will be, as the bid and ask prices must have previously overlapped to create the volume. The more open interest at strike price, the tighter we assume the bid/ask spread will be, as there are outstanding open contracts that still can be closed and that we can trade with.


Honorable Mentions:

What liquidity segment is your favorite? Leave your vote in the comments below, and as always, reach out to us at support@dough.com for any and all trading questions!