Should I care how wide Bid/Ask Spread is???

frcrilly · Jan 20, 2011

Hi All,

Iâm presently trading options on a simulator. I have the following query which is best explained in an example.

Image two call options for two different stocks with different bid and ask spreads but all other factors being equal.

Stock A Bid 0.89 Ask 0.91 Mark 0.90
Stock B Bid 0.70 Ask 1.10 Mark 0.90

Using a simulator, I can simply buy either call option at itâs Mark value of 0.90. I have always been thought that narrow Bid/Ask spreads are good and wide Bid/Ask spreads are bad. If I can buy the call option for 0.90 in both cases, why should I care how wide the Bid/Ask spread is? (does the difference become apparent if I switch from using a simulator to using real money?)

Any with this will be greatly appreciated. Thanks In Advance for all responses.

MTE · Jan 20, 2011

The difference between a simulator and real money is like night and day. Just because you always get filled at mid point on a simulator doesn't mean that you will get filled at mid point in real life. In fact, you are likely to have to pay slightly above the mid to get filled on a buy, and slightly below the mid to get filled on a sell. And sometimes you may need to pay the full spread to get filled.

So, yes, the bid ask spread makes a huge difference, especially when you need to get out of a position.

chartman · Jan 20, 2011

Quote from frcrilly:

Hi All,

Image two call options for two different stocks with different bid and ask spreads but all other factors being equal.

Stock A Bid 0.89 Ask 0.91 Mark 0.90
Stock B Bid 0.70 Ask 1.10 Mark 0.90

Using a simulator, I can simply buy either call option at itâs Mark value of 0.90. I have always been thought that narrow Bid/Ask spreads are good and wide Bid/Ask spreads are bad. If I can buy the call option for 0.90 in both cases, why should I care how wide the Bid/Ask spread is? (does the difference become apparent if I switch from using a simulator to using real money?)

It is not as important as to where you can open a position as it is to where you can close a position. A wide spread normally means less actively and volume which could cause wide price swings.

spindr0 · Jan 20, 2011

Quote from frcrilly:

Image two call options for two different stocks with different bid and ask spreads but all other factors being equal.

Stock A Bid 0.89 Ask 0.91 Mark 0.90
Stock B Bid 0.70 Ask 1.10 Mark 0.90

In line with what the others have replied, if in the real world they're filling only at actual B/A prices then with stock B, you have a 40 cent loss at the starting gate.

Simulators that fill at the midpoint are a disservice to wannabe traders

nazzdack · Jan 20, 2011

Quote from chartman:
----A wide spread normally means less actively and volume which could cause wide price swings.

1) A wide bid-ask spread can be the result of wide price swings, i.e. high implied volatility, which can mean less trading activity and volume in the option. The spread can be "overcome" by trading against movement in the underlying stock.
2) Stock-A looks like a large-cap option.
3) Stock-B looks like a bio-tech stock on the verge of a major announcement.

stinkyfelix · Jan 20, 2011

Quote from spindr0:
Simulators that fill at the midpoint are a disservice to wannabe traders

When using a simulator, make a mental note that your orders are being filled at the BID or ASK price only and then see how profitable your trades are...

With high volume, penny spreads, the difference is very small, unless you are scalping for a few cents.

With low volume options with wide spreads, as another indicated, you start out with a significant loss and have a much greater chance of closing out the trade at a net loss....

The quote above is very true...

Wilt · Jan 20, 2011

Yes, it matters big time. An option with a spread of that percentage is garbage. Don't bother to trade it; noone else is, otherwise it wouldn't have spreads like that. I have gotten fills on options like the one above, and yes, generally you will get filled at the midpoint if it correlates with the option's expected value given the price of the stock. But, with an option like that, you're at the mercy of the market makers. They may not fill you until a significant move against you is afoot and they have no choice but to do so. And if that happens, do you really want it?

Wilt

limitdown · Jan 20, 2011

Quote from frcrilly:

Hi All,

Iâm presently trading options on a simulator. I have the following query which is best explained in an example.

Image two call options for two different stocks with different bid and ask spreads but all other factors being equal.

Stock A Bid 0.89 Ask 0.91 Mark 0.90
Stock B Bid 0.70 Ask 1.10 Mark 0.90

Using a simulator, I can simply buy either call option at itâs Mark value of 0.90. I have always been thought that narrow Bid/Ask spreads are good and wide Bid/Ask spreads are bad. If I can buy the call option for 0.90 in both cases, why should I care how wide the Bid/Ask spread is? (does the difference become apparent if I switch from using a simulator to using real money?)

Any with this will be greatly appreciated. Thanks In Advance for all responses.

that's a very good question,

I never knew about this "mark pricing"

is this some feature of your software?, what software and simulator are you using?, is it available to the retail public or just in-house software?

is this some standardized means of splitting the bid/ask spread and crossing markets at the mid point?

surfer25 · Jan 21, 2011

Quote from MTE:

The difference between a simulator and real money is like night and day. Just because you always get filled at mid point on a simulator doesn't mean that you will get filled at mid point in real life. In fact, you are likely to have to pay slightly above the mid to get filled on a buy, and slightly below the mid to get filled on a sell. And sometimes you may need to pay the full spread to get filled.

So, yes, the bid ask spread makes a huge difference, especially when you need to get out of a position.

I think you trade options a lot. Can you please tell me what price you are usually able to be filled at if the bid is 12.40 and the ask is 12.90?

Thanks.

MTE · Jan 21, 2011

Quote from surfer25:

I think you trade options a lot. Can you please tell me what price you are usually able to be filled at if the bid is 12.40 and the ask is 12.90?

Thanks.

There is no hard rule on this as it really depends on the situation (i.e. a lot of factors can come into play here). Anyhow, the mid in your example is 12.65, so if I wanna buy then I would initially try @ 12.70. If that doesn't work then, assuming I'm ok with paying more, I would try at 12.80. Similarly on the sell side, initially try at 12.60...and then possibly at 12.50.

In addition, it is usually easier to get filled on a spread (vertical, condor, etc) close to the mid point, just because the spread is already a partially hedged position so a market maker may be more willing to trade it than an outright call/put.