Risks When Trading Illiquid Options

Updated: September 13, 20253 min read

1. Background

When trading options, the liquidity of the respective option chains plays a crucial role. While highly liquid markets like SPX or SPY typically offer tight spreads and reliable executions, there are numerous underlyings whose option chains are significantly less liquid. This particularly affects contracts with low trading volume or low Open Interest. In such cases, the risk increases that executions occur at worse prices or don't go through at all.

OptionsApp always executes orders exactly as configured, regardless of the liquidity of the chosen underlying. It is therefore the responsibility of the user to realistically assess the risks when using complex structures or order types in less liquid markets.

2. Risks of illiquid option chains

Illiquid option chains (or those with lower liquidity than, for example, SPX) can be problematic in multiple ways. Typical risks include:

Higher slippage: Wide Bid/Ask spreads lead to worse execution prices.
Non- or partial execution: If there is no counterparty, an order may not be executed in full or at all.
Leg risk: With multi-leg constructs, the risk of high slippage or non-execution can intensify further.
Increased risk with long expiration periods: Options with distant expiration dates often have low liquidity.

Especially when multiple factors combine (complex structures, long expiration periods, and thin volume), the probability of unfavorable executions multiplies.

3. Impact of structures and expiration periods

The more complex a Trade Template is designed, the more liquidity issues affect it. Structures like Butterfly, Iron Condor, Reverse Iron Condor, or Calendar Spreads contain multiple legs that must be executed simultaneously. As a rule, Bid/Ask spreads increase the more complex the structures become.

Additionally: The longer the expiration period, the more likely liquidity will decrease and Bid/Ask spreads will widen. Long DTE therefore increases the risk of slippage and makes it more difficult to reliably close positions.

4. Stop management and order types

A particularly critical point is the use of Stop-Loss orders. A Stop Loss is an order that is executed as a Market Order and uses the next best, potentially very unfavorable price. If the Bid/Ask spread is very wide at the moment of execution, this can lead to high slippage and thus high, unintended losses.

REL Orders can also be problematic: They "attach" to existing quotes but may simply find no counterparty in less liquid markets. The risk of non-execution is significantly higher here. The REL Order settings (offset and limit) must be configured considering the liquidity and expected Bid/Ask spread.

5. Recommendations for trading

To minimize risks when trading less liquid option chains, we recommend:

Avoiding complex structures: In illiquid markets, simple Verticals are usually more suitable than Combos with many legs.
Choosing moderate expiration periods: Trade very long DTE only in conjunction with sufficient volume.
Check before initial execution: Are the opening and closing criteria (Stop Loss, Exit Conditions, ...) set appropriately considering the Bid/Ask spread, Open Interest, and trading volume?
Ensure monitoring: Illiquid trades require closer observation. If in doubt, the user must be able to disable OptionsApp monitoring and manage the position manually via TWS.

6. Important notice

Trading illiquid option chains, more complex structures, and longer expiration periods can overall lead to higher risks. Users must be aware that poor executions can occur, particularly with Market Orders (such as Stop Loss).

For this reason, we strongly recommend that only very experienced options traders trade underlyings with less liquid options.