Bid Ask Spread question

[dohdat]

Hi there, I am trying to backtest credit spread strategy on very liquid stocks and etfs. Is it realistic to get the mid price if the bid and ask spread is around 20%? For example, bid is 4.75, ask is 5.55, mid is 5.15 for PYPL. Will it be difficult to get filled? Thanks.

 

[Robert Morse]

You will never know. You need a starting place. For the purpose of backtesting, I would do midpoint-$0.10 for a credit spread and wide markets.

You should take a look at this service, https://cmlviz.com/

 

[ajacobson]

"Hi there, I am trying to backtest credit spread strategy on very liquid stocks and etf"

20% b/a doesn't sound like the options are as liquid as the underlying. You can test to the midpoint, but(depending on the trading venue) those quotes look to be about the maximum allowed b/a. I'd look for something with more liquid options. Are those quotes long-dated or deep ITM, because they don't appear very liquid. Without knowing more the liquidity is in question.

 

[dohdat]

http://opcalc.com/1sbu
This is the spread I'm looking at. I thought PYPL is a very liquid stocks. But maybe I'm wrong. I mean it has 515,675 open interest. I will go back to the drawing board then. haha. thanks

 

[Robert Morse]

dohdat,

Open interest in options does not tell the entire story, Liquid options have tight spreads and customer bids and offers on many exchanges. Open interest could include a few institutional trades and little depth and liquidity when you need it.

 

[ajacobson]

Robert is 100% spot on. Although some open interest is better than none - it is frequently not a good measure of liquidity. 20% b/a would send me elsewhere.

 

[spindr0]

Is your source of back test data reliable? Traditional EOD data is often stale (last option trade does not match closing price of the underlying) and the B/A often widens at the close (last B/A at EOD). Something like TOS's ThinkBack might be more reliable.

 

[dohdat]

Is your source of back test data reliable? Traditional EOD data is often stale (last option trade does not match closing price of the underlying) and the B/A often widens at the close (last B/A at EOD). Something like TOS's ThinkBack might be more reliable.

I think it's because the spread is so deep ITM, that's why the spread is huge.

 

[sss12]

Robert is 100% spot on. Although some open interest is better than none - it is frequently not a good measure of liquidity. 20% b/a would send me elsewhere.

Do you (or anyone) have any rules of thumb for the max width of an B/A spread on a atm option ?

 

[spindr0]

I think it's because the spread is so deep ITM, that's why the spread is huge.

Spreads are always wide when deep ITM. But they sometimes they widen at the close and conversely, in the morning, they narrow a bit during the first hour. It also depends on the liquidity.