Options Spreads Bids/Ask Spreads on IB Paper Trading Account

[aw779]

Hi everyone,

I'm new to options trading and I'm currently playing around with some strategies in an IB paper trading account.

I'm a bit confused - I built the following spread and entered by just paying the offer:
Sell 4 GBP FOP May08'20 1.295 PUT @GLOBEX
Buy 12 GBP FOP May08'20 1.265 PUT @GLOBEX
Sell 8 GBP FOP May08'20 1.235 PUT @GLOBEX

And to my surprise once filled I was already down -439 in unrealized PNL Immediately (shown below):

So I checked the bid/ask spread and saw it was
-0.0038 x -0.0016


It doesn't make sense to me that an options spread with a market value of $755 loses $439 by paying the offer and hitting the bid to get out without the spread value moving at all.

Can someone give me some clarification as to why I'm immediately down so much P&L on this trade when the spread value and underlying has barely had time to move? Of course I would expect to be down some amount due to bid/ask spread at the outset of any trade but this seems absurd? what am I missing? Is it something to do with the fact I'm on a paper trading account?

Thanks guys.

 

[guru]

Great example of why no one ever places market orders for options. Once anyone experiences this they’ll never place a market order again. So simply don’t place market orders, or you’ll be enriching market makers who hunt for these types of orders when someone will pay them whatever they want. This loss is actually small comparing to how much people lose by placing market orders.

Can someone give me some clarification as to why I'm immediately down so much P&L on this trade when the spread value and underlying has barely had time to move?

Nothing changed so the spread value is the same as it was. You simply lost money by overpaying (or getting less credit) by placing a market order.

Is it something to do with the fact I'm on a paper trading account?

Paper trading is highly inaccurate, but in this case if you placed a market order to pay or collect whatever price anyone will give you then this type of scenario is quite common.
While trading options on paper sucks mainly due to wide bid/ask spreads that make it very difficult for the broker to assess when an actual limit order would’ve gone through, if at all.
I sometimes wait hours or days for such orders to go through in live accounts, and have to continually fiddle with the limit price to see at what price it may finally go through.
Some options are more liquid than others and I usually shoot for getting the mid-price, but adding a few dollars (to the final dollar cost) loss per option as slippage, and to allow market makers to make small profit and decide to take my trade.

 

[aw779]

Hey thanks so much for taking the time to respond, that was really detailed and has helped me on my journey more than you probably imagine. I have a few follow up questions if that's okay:

So am I correct in thinking if a MM has a theo of say 100 they might "optimistically" sit on the offer at 110 in case a fish like me comes along and lifts them but if you come in and bid 101s they'll likely sell it to you there too?

To be clear no one really enters or exits options spreads at market at all? I assume if you're just buying single ATM calls in ES or something it's less critical?

So in my case where the bid/ask spread was -0.0038 x -0.0016, if I had entered at more or less the mid price and exited at more or less the mid price assuming the spreads value didn't change I would still lose some amount on the round trip. But by entering and exiting at market (again, assume the spreads value didn't move in the mean time) I would lose far far more on the round trip.

As you mentioned I have also noticed that when I create more complex structures with multiple legs, liquidity really gets thin. There's still a market, as in there's still a bid and offer, but ts very wide and usually for only a handful of units. Stands to reason. In these cases I now know not to enter at market, but instead of just entering a bid, waiting, bidding a bit higher, waiting, bidding a bit higher, waiting, and so on until l I finally get a fill, couldn't I just cut all that out and RFQ (aware you can't do this on paper trading). Or is RFQ only available when there isn't even a live quote?

And finally, this all must mean that the unrealized P&L figure is showing you your unrealized P&L assuming you were to exit at market, and in reality it's actually likely to be a touch higher because more often than not you'll get filled at a better price than the bid or offer when you exit with a limit order?

Thank you so much you have helped

Hey, I really appreciate your reply.

 

[guru]

So am I correct in thinking if a MM has a theo of say 100 they might "optimistically" sit on the offer at 110 in case a fish like me comes along and lifts them but if you come in and bid 101s they'll likely sell it to you there too?

Yes.

To be clear no one really enters or exits options spreads at market at all? I assume if you're just buying single ATM calls in ES or something it's less critical?

Yes, no one really enters them at market, unless maybe the bid/ask spread is really tight. But that’s still the same as a limit order because you can decide that you’re ok with the full width/spread and that’s your limit.

couldn't I just cut all that out and RFQ (aware you can't do this on paper trading). Or is RFQ only available when there isn't even a live quote?

I never used RFQ as that’s for institutional investors and I don’t even recall seeing this, but to be specific, each options order does go through a quick 100ms auction between market making computers where they can improve your price. This does help with accidental orders where I may enter a wrong price, especially when the mid price is wrong or at least skewed because some retail trader is waiting to buy a single leg at their limit, which may be already close to the previous mid.
But those auctions work maybe half the time, hard to tell. And may depend on the specific underlying, options liquidity and/or possibly number of market makers.
So you won’t always get totally screwed and sometimes will be surprised with getting a decent price, but you’d still learn not to use market orders anyway. Occasionally you may simply get fills on some legs waiting to get filled. You may also cross some other spread orders that may not visibly affect the price of a single option. Basically you may (accidentally) compete with market makers and also get decent price by taking or providing liquidity on some legs, trading against other resting orders. Basically there are scenarios where you can get a decent price, but using market orders would require a lot of luck.

The unrealized P&L may somewhat depend on the broker because they may calculate the current value differently - some based on Mid price and others on the market price that may also take the last sale price of some legs into account, as some options may not sell in days while others may not have a bid or ask. I don’t recall how IB does this but it gets skewed after hours to unrealistic prices/P&L (on some options and combos), so I don’t even pay close attention anymore. It may look acceptable during the day, but only I can estimate what some complex combos may really be worth. Some of my combos are so illiquid I just have to wait till they expire at $0, even when they show positive P&L. While there may be opportunities to get out at a reasonable price, especially when there is interest from retail traders and they’re the ones unable to get their orders filled - basically you may provide liquidity and skip MMs at times.

 

[d0rian]

The unrealized P&L may somewhat depend on the broker because they may calculate the current value differently - some based on Mid price and others on the market price that may also take the last sale price of some legs into account, as some options may not sell in days while others may not have a bid or ask.

Yeah, OP what you're seeing has to do with the above combined with the fact that simulating Limit trades in a paper account for options with wide bid/ask spreads will be super inaccurate - I remember running into this issue too when I was trying to simulate my options strategy in a paper acct. Your "orders" aren't actually getting sent to any exchange, of course -- so it's basically just a play-money scenario run entirely on the live prices you see displayed in TWS.
E.g. Option contract X has live bid/ask of $1.20 / $2.00, but there are likely a ton of hidden price points in between where you'll get a fill with a live order; e.g. if you put in a real-money Limit Buy for 10 x $1.95, you'll almost certainly get filled, but paper money you won't because IB/TWS has no way of knowing there's that hidden $1.95 Offer unless it's the NBBO displayed offer. So you're getting filled at the equivalent of a market order (above FMV), but IB's P&L calculator is using midpoint (or some other blended methodology like guru wrote about) to show an unrealized loss.

 

[aw779]

Thanks guys cant express how much both of you helped me. You saved me a lot of time trying to figure that out on my own. I'm glad I found this forum.

Thanks.