What Does Liquidity Have to Do with Scalping? | Best Practices
Oct 14, 2015
Periods of increased market volatility can be fruitful for traders that focus on (and excel at) "scalping."
On a recent episode of Best Practices, Tom Sosnoff and Tony Battista introduce the topic of scalping and some of the key points that traders in this arena need to consider.
Tom and Tony define scalping as a style of trading that attempts to capture small profits from shorter term price movements. A single trade in a scalping strategy is usually called a “scalp.”
The approach to scalping varies by trading product and might be executed around a core position or as its own stand-alone strategy. Scalping can be as simple as recognizing that a stock is trading in a tight range and capitalizing on that pattern by buying the lower end of the range and selling the higher end of the range.
Traders often use scalping to defend against negative theta on delta neutral, long premium derivatives positions. A position such as this will get shorter deltas when the underlying goes down and longer deltas when the underlying goes up. By "flattening" those deltas (buying or selling them based on the movement of the underlying) a trader can monetize the movement - especially if the stock moves quickly in the opposite of the original scalp.
If you buy 5,000 deltas (shares) and the stock rebounds $5, you will have considerable profit. The same as if you sell 5,000 deltas and the underlying craters.
As Tom and Tony indicate in the Best Practices episode, such trading can be highly subjective.
Some traders may choose to flatten all deltas at one point in the trading day (i.e. 2pm), while others may do so on a weekly or monthly basis.
As indicated on Best Practices, and shown below, liquid products tend to be the most ideal for scalping:
Obviously, if there isn't sufficient liquidity in a product as it trades to the most extreme points of its range, then it is much more difficult to monetize movement (i.e. make a profit).
A great example of an epic scalping opportunity was of course the well-known Flash Crash (May 6, 2010), which was an absolute dream come true for scalping-oriented long premium options strategies. Those who were lucky enough to buy during the throes of that panic were rewarded beyond their wildest dreams with the strength of the ensuing snapback.
Keep in mind, however, that the liquidity at the bottom in such unusual moves can be inconsistent at best. While the listed high and low of many stocks on the day of the Flash Crash were jaw-dropping in terms of absolute range, the number of shares that traded at the extreme points (especially the lows) was very small, especially in illiquid securities.
Tom and Tony outline some key points to keep in mind when considering a scalping strategy, as listed below:
There are a great number of scalping philosophies and approaches that exist for a wide range of trading products. This means the approach a trader might select in any single product requires careful consideration.
We encourage you to watch the full episode of the Best Practices focused on scalping in order to further develop your arsenal of knowledge on this very important topic.
And please don't hesitate to follow up with any comments or questions at firstname.lastname@example.org
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com.
tastytrade is a trademark/servicemark owned by tastytrade.
tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”).
tastyworks, Inc. (“tastyworks”) has entered into a Marketing Agreement with tastytrade (“Marketing Agent”) whereby tastyworks pays compensation to Marketing Agent to recommend tastyworks’ brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastyworks. tastytrade is the parent company of tastyworks. tastyworks and Marketing Agent are separate entities with their own products and services. tastytrade has different privacy policies than tastyworks.
Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.