Measuring execution quality on NDX index options with effective spreads

SSince October 2018, when we published the first research paper to measure the liquidity of Nasdaq-100 Index (NDX) options, the value of the index has more than doubled. A single contract now exceeds $1.32 million in notional value and warrants an update for traders to understand the transaction costs of trading NDX. Due to the complexity of measuring liquidity, we take advantage of this article to dive deeper into the metrics commonly used by traders to assess liquidity.

We have reviewed option execution data to shed light on the average execution slippage or effective spread to provide guidance and transparency while dispelling myths about perceived liquidity. Products such as options on the Nasdaq-100 (NDX) index with large options chains are most likely to be perceived as illiquid due to the wide quoted bid/ask spreads. We have evaluated over 50,000 executions of NDX for the average execution price relative to the midpoint. We found that most volume and larger notional contracts were trading well below 1% of the midpoint, showing ample liquidity and extremely low transaction costs, even when standard liquidity metrics suggest otherwise.

Option slippage

Before diving into the metrics, we first want to define how we measured our results. We define slippage as the distance between the execution price and the midpoint of an option. The greater the slippage when a trade is executed further from the midpoint. Traders want orders to be executed as close to the midpoint as possible to minimize transaction costs and improve profits. We can provide insight into the true liquidity of NDX options by analyzing where trades are executed relative to this midpoint. We calculate slippage in dollars and percentages in the example below.

Bid/Ask Spread: $2.50 (ask price) – $1.50 (bid price) = $1.00

Effective spread: $2.05 (execution price) – $2.00 (midpoint) = $0.05 Slippage

Percent slip: $0.05 (slippage) / $2.00 (midpoint) = 2.5% slip

Perception of liquidity

Many traders will use bid/ask spreads and open interest to gauge an option’s liquidity; however, we found in many cases where these measures were poor indicators. While it is true that options with high OI and volume generally have high liquidity, the reverse is not always true. There are many reasons why an option with zero or low OI and volume is very liquid and will be executed within pennies of the midpoint. Also, the bid/ask spread is arguably a better measure of liquidity for most options, but even that has its exceptions. We found very little correlation between slippage and the size of the bid/ask spread. However, by looking at actual trade executions, liquidity can be measured by the ability of large orders to be bought and sold near the midpoint.

Liquidity indicators

These results lead us to focus on the metric that impacts your business outcome, slippage. As noted in the summary, the average execution only traded within 2.55% of the midpoint. Additionally, the average dollar slippage was $0.41 per contract. This translates to a slippage of only $41 on a $1,320,000 contract or 0.000031%. However, that number was misleading as we dug deeper. Most of the volume and large trades were executed at much better prices. In addition, 27.9% of executions are filled mid-term! We summarize our findings on slippage along with the factors that affect liquidity, contract size, option price and delta to help provide research on where orders are executed. Our research shows that NDX has much deeper liquidity than what is shown on screens.

Contact size

Negotiated contracts

We were pleasantly surprised to see that both retail and institutional traders received quality fills with consistent slippage by trade size. Even trades over $65 million in notional value in a single execution all filled with less than 1% slippage, showing the true deep liquidity of the NDX product.


Option prices

The price of an option is usually a major factor in the slippage of order executions. An index valued at over $13,200 will often create quite high option prices. Naturally, far out options tend to have higher slippage, but when you view slippage by dollar amount, it’s well below average.


Delta chart

The data broken down by Delta is not surprising, as options that have a very low level in Delta (far from the current price) will generally see larger slippages. While credit spreads with very low deltas are typical of index options trading, the data shows that slippage increases as a percentage of the execution price at the extremes.

In conclusion, we find that despite lower open interest, larger volumes and bid/ask spreads, which may signal a lack of liquidity, the reality is quite the opposite. There is a large pool of cash available on Nasdaq-100 index options. This knowledge seems to reflect institutional traders who execute large volumes within 1% of the midpoint, but less so among retail traders. Additionally, credit spread sellers will find better liquidity by removing deltas slightly higher, and higher priced options offer better liquidity. Finally, our data shows that 96.41% of executed orders were executed within 2% of the midpoint. This crucial data point is what traders can use median and execution data to inform decisions on placing limit orders with NDX.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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