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I am trying to learn more about options trading and option strategies. One thing that I have noticed is that for a lot of large cap stocks such as KO and UPS, very often there is a very low open interest compared to the amount of shares traded in the underlying.

For example, with KO, only a few dozen contracts traded even though the average daily trading volume of the stock is around 17 million. So why are these volumes so low?

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  • $\begingroup$ You will find much more volume and open interest in the standard expirations as opposed to the weekly expirations. $\endgroup$ – amdopt Aug 10 '20 at 18:45
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Note that the volume and open interest is spread across different expirations and strikes but two reasons why the option volumes are very low compared to equity volume are:

  1. An option is for 100 shares of the stock so the inherent leverage means that investors can create larger positions w/ less option contracts compared to trading the underlying.
  2. There are simply less investors trading options due to their complexity.
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  • $\begingroup$ I thought maybe the reason might be that a lot of trades are done OTC?. If I am a fund manager and I wanted to hedge a relatively small postion in KO at the current market price. Let's say 10,000 shares. So I need to buy a 100 put options atm. I thought these kinds of transactions should be happen much more often than what is shown in the option table. $\endgroup$ – Andreas Aug 10 '20 at 17:57
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    $\begingroup$ That could also be a reason. I don't know what percent of vanilla option volume exchanges OTC but I'm curious. It's also hard to measure the total amount of liquidity for certain options until you execute as you don't know how the market makers will react. In some cases, they might happily take all your volume. Also, in your example you would have to buy deep ITM puts, not atm, so that the delta is close to -1 and acts like the underlying. $\endgroup$ – Quantoisseur Aug 10 '20 at 18:16
  • $\begingroup$ I mean atm assuming one alreadys own the underlying and just wants to buy protection but yes you are right $\endgroup$ – Andreas Aug 10 '20 at 20:10
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There are a number of reasons why Open Interest is low compared to trading in the underlying. However, that doesn't always mean that liquidity is low. I'll repeat the two reasons mentioned in the other Answer:

  • Options are for 100 shares per contract so in comparison, the volume of shares traded is 100 times

  • Options have more complexity and fewer people utilize them

  • Newly added expirations start with zero Open Interest which gradually increases over time.

  • Low Open Interest doesn't always means that there is low liquidity. In order for Open Interest to increase or decrease, the two parties must be BTO + STO (new contract created) or BTC + STC (existing contract terminated). When the counterparties are BTO + STC or BTC + STO, contracts are changing hands but Open Interest does not change. IOW, many options could be actively traded during the day (liquidity) but there is no change in the Open Interest.

  • Many option buyers are speculators and they are looking for the big win via the leverage of options. For that reason, they buy out-of-the-money options (OTM), not realizing the lower probability of winning. This is quite obvious in a stock like KO which has been range trading for four months. If you look at its option chain, you'll see this pattern where in general, Open Interest is higher for OTM calls and higher for OTM puts.

  • For stocks that offer weekly options, there are eight weekly expirations plus the regular every three month expirations plus a LEAP expiration (and sometimes more). An extreme example would be SPY which has 35 expirations. Therefore, though it's skewed toward nearer expirations, daily option volume is spread across many expirations, diminishing the number of contracts traded per expiration. Getting back to KO, nearly 40,000 contracts traded on Friday, representing nearly 4 million shares. That's a lot of liquidity but as mentioned, it's being spread over a lot of expirations so it appears to be low.

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