How to evaluate the bid-ask spread?

[Spaghetti Code]

When I trade options, I usually like to work with SPY and QQQ LEAPS. Trading these tend to have pretty large spreads for new expiration dates, like the recent Dec 2023 options. The options there have a bid-ask spread of around $5, which is pretty wide for the premium. In my price range, I am looking at options around $20 -$50, so the spread is nearly 10%.

What I am wondering is how measure the impact of that spread on my trading performance? I plan on holding these for a few years, so I expect the spread to come down over time (as it has on the Dec 2022, and Dec2020 expirations). It's hard to tell if I overpaid or underpaid, because in recent times the options have always gone up in value. It's hard to tell if a given bid-ask is too much, or justifiably wide.

Are there any rules of thumb on what an acceptable spread is? What do you all use when looking at the spread to see if it's too much, or a deal? And how do you keep track loss due to trading [rolling] options frequently?

 

[Jack1960]

You can put limit orders to buy a few cents above the bid. You will be surprised how many times you get filled.

 

[Spaghetti Code]

You can put limit orders to buy a few cents above the bid. You will be surprised how many times you get filled.

I noticed this at first, but it also seems like if it doesn't immediately get filled, I have to walk the bid price up when buying. I have my suspicion that HFT firms identify this behavior, and refuse to fill it until it reaches the ask.

 

[big_premium]

the spread is extremely large even on S/T options for mid-cap US stocks, so always I had the same question: Who buys them with market orders???

 

[morkel635]

If you want to keep a check on your trade, try using some different strategies for that. You can make good use of stop loss or try placing a limit order to avoid any losses. That’s what I do for my trades and that actually works. I’m exploring some brokers these days and my friend told me about trying etoro and fxview. They seem okay to me. Will try their demos to get a better idea.

 

[longandshort]

You should "price the option" to figure out an appropriate "midpoint" and then rest your order there (limit).

To do this:
Pricing the option can be done using an options calc like the one on the CBOE website.
Next, solve for implied vol of bid and ask. Price the trade using either your estimate of implied vol, or some midpoint that you think is likely. See the impact on the price. Input your limit order with that price. Wait to get filled.

Note:
If you are just looking for a leveraged position, then analyzing the option price does not make too much sense. Instead, pay closer attention to your payoffs and breakevens on the bid/ask.

 

[Spaghetti Code]

If you are just looking for a leveraged position, then analyzing the option price does not make too much sense. Instead, pay closer attention to your payoffs and breakevens on the bid/ask.

The relevance of the spread is in how often I should roll my position into longer-term positions. If a B-A spread is too high, I should not roll so frequently, as it will show up in the P/L.

 

[Tommcurrans]

the spread is extremely large even on S/T options for mid-cap US stocks, so always I had the same question: Who buys them with market orders???

These large spreads don’t happen in every hour. It is the reason that we have to look out for specific hours of trading itself. A huge spread in the market means that not much trading is happening in those hours. So we can conclude that maybe in the case of the stock markets these are lunch hours or late at day hours. In case of forex which is a 24 hour market, they can happen for specific trading periods like when the EUR/USD reaches a low trading point, relatively in the wee hours of the day.

 

[scadderoccasional]

People buy on the market orders usually. Because the spreads are usually low in the stock markets and goes to the exuberant levels only on certain times of the day, where most of the traders themselves stop doing trade.

 

[Tommcurrans]

People buy on the market orders usually. Because the spreads are usually low in the stock markets and goes to the exuberant levels only on certain times of the day, where most of the traders themselves stop doing trade.

The spreads in the markets are dependent on the volume of trade plus the broker chosen. I have been trading in the forex market for several years. The brokers which I choose (Fxview and XTB for now) are for the same reasons. Ultra low spreads are essential for trading in a number of markets especially in forex. This is a very essential parameter to look for while trading. Option trading is also good and can give you higher win ratios as compared to market orders.