Dear all, I came across a question on capacity of a specific strategy, and I wish someone could show me some pointers. For instance, if I have a strategy that only trades S&P500 options. How does one estimate the capacity of such a strategy? Would you look at avg daily trading volume/value? Total Open Interest? Your help is much appreciated! Thank you so much!Regards,David

It all depends on the nature of the strategy in terms of the likely holding times and desired timeframe for creating and liquidating positions. If your strategy slowly creates positions that are held until expiration, then the capacity would be some fraction of the open interest. But if the strategy uses intraday entries and exits, the capacity will be a small fraction of the daily volume. The shorter the holding time and the faster you plan to move in and out of positions, the more you need to look at intraday volume patterns. If you are backtesting, consider what would happen if your orders were executed over N-periods instead of in the period you identified as the best entry/exit point.The hard part is in estimating market impact -- that each of your orders moves the market against you and eats into your profits. This will determine what percentage of the market's volume or open interest you can do and still be profitable. I've not looked for studied of this in the options market, but some data might be out there.

Not as important for S&P options but also look at trading volume during stress periods, i.e. times when you might be forced to sell. This is what really matters.

GammaSkimmer raises a key issue -- its not the average volume that determines capacity, but some worst-cased biased value. You might look at the minimum of the volumes between the entry and exit sides and consider the joint distribution of price movements and volumes.

Thank you so much Traden4Alpha and GammaSkimmer!David