Liquidity Traps and Max Pain
By Ernie Varitimos
February 15, 2022
0:00 / 15:00
Liquidity Traps and Max Pain

Okay. 3, 2, 1. And we alive. I don't see myself yet. There I am I doing friends or any here? And this is the zero days to expiration podcast. Episode number 78. It means that there are 76 other episodes chock full of options, expiration genius. We're actually, there's only 75 because there still is that missing episode, episode number 70, which does not exist someday.

It will appear today. We're going to talk today. It's going to be a short podcast. And it's really going to state a modification to our strategy, not a modification, really more like an ad junked to take care, not take advantage, but take care or adjust to the current market conditions. These market conditions that I'm speaking of is ultra low liquidity.

So over the past two months or so leading up to the fed finally coming up with some sort of clarity around whether or not they're going to hike interest rates to turn that off hike, interest rates, the liquidity in the market has been slowly diminishing. And I'll explain this in this.

Liquidity. First of all, can be measured in options terms by open interest. What is open interest? Open interest are the number of contracts that are in play in the market. Now, as you know, we trade the E-mini futures with the zero DTE event and we trade the futures, the E-mini S and P. That's the S slash E S we trade that because it has a lot of advantages over the SPX or the spy.

And the principle advantage it has is. It trades 24 hours a day. Well, it's actually 23 hours a day, five and a half days a week, but that's a huge advantage. Plus compared to the SPX, it also has volume. The SPX has no volume because it's not real. It's just a calculated index. You can't actually trade the SPX.

You can trade derivatives of the index. The other advantage that the E-mini futures has is that it is not subject to the pattern day trader rule like the SPX is. So that means that people with small accounts can take advantage of this wonderful zero dash DTE strategy. Otherwise, they would need an account that has at least $25,000 in it.

And they'd, and if it was under that, they'd have to be taking extra care to make sure that they do not violate that rule. Otherwise they could get slapped with a restriction that will keep them from trading for up to 90 days. So all of these are advantages of the . One of the disadvantages is that compared to the SPX or even compared to the spy, the E-mini futures has a lower volume and a lower open interest.


As a result, as I said, open interest are the number of contracts that are actually in play. That's the number of puts and calls that people put on, whether long calls, long puts, whatever it is. It's the number of contracts that are in play. Now the interesting thing is that this is a proxy for liquidity, will show up as a histogram at the different strike prices you'll notice that open interest seems to congregate over a certain price level.

And this is very akin to the volume profile where the volume profile has a lot of volume associated with different price levels and they appear as nodes on the profile or Wells, where there is a lack of volume. And we use the. In the volume profile world, because we know that when there's a large node surrounding a price level, we know that price tends to gravitate towards that node.

Well, it's the same thing with options. When you have open interest that is built up around a particular strike price, that price tends to gravitate towards that level. Now, one thing that we've been experiencing lately are liquidity traps, where you think that you have the liquidity necessary to enter a trade and that there are counter parties there that you have really no worry about getting in and out of the trade with a halfway decent spread and you can get a good price going in.