In recent weeks, I am unable to roll options due to the bid-ask spread, and trying to split the bid-ask is not working. In my over a decade of trading this is the first time I am having these challenges. Now, I am rethinking weekly covered calls as unviable…
The market makers are fleecing the retail option traders.
One needs to be aware of how the market and the stock are moving. Option prices are highly influenced by “animal spirits.”
To be safe, I use Good-Til-Cancelled (GTC) limit orders, I never use market orders with options, never, never, never!
The Captain
Nothing to do with option pricing. On an average week I do about 75 to 100 trades. I am doing that kind of volume for the the last several years. I have not seen bid-ask spread this wide and rolling of options fail like recently.
The bid-ask spread of 5 to 10 cents are normal, I am seeing for certain stocks, the spread are as wide as 5% of the underlying. These are not illiquid names like REIT’s. Something is broken in the market.
@Kingran I don’t trade options so I don’t understand the implications of this.
When something suddenly changes in the markets it can be a signal of an underlying change that may have broader significance. What could that be?
Wendy
Don’t know. We are actually seeing record option volumes. The option volume on names like PLTR are insane. Set aside that, even in names like $TLT which is fairly liquid name, I could not split the bid-ask spread. For ex, here is the bid-ask for Monday expiration of $TLT. See the spreads for $87, $87.5, $88, how they have tight spreads of 1 or 2 cents. This is normal. The market makers make their money in their spread, and when I want execution I don’t bother to split the spread and let them have their profit.
If you are trying to roll $86, $86.5, the bid-ask so wide and if you try to split, those trades are not going through. This is not illiquid name. This is forcing me to either go further on duration or often have to let the stock be called/ assigned. From the second image you can see how the spread tightens for later durations.
I initially thought may be there is not enough demand/ supply but there is significant bid/ ask volume except that the spread is wide.
@Kingran are market makers allowed to keep a trade from happening if they want a larger spread even if traders would have accepted a narrower spread?
Wendy
I don’t think so. But, there are nuances. On many names the option prices are increments of 5 or 10 centrs. So, if you are trying split the spread only MM’s can do that.
Wendy, I don’t understand @Kingran’s logic.
When you place an order it goes into the order book and the orders are executed in a first come first serve order when there is a matching bid. There are basically two kinds of orders, market and limit. Market always has a matching bid. When there are lots of traders the market does not need market makers.
The basic role of market makers in the options exchanges is to ensure that the markets run smoothly by enabling traders to buy and sell options even if there are no public orders to match the required trade. They do this by maintaining large and diverse portfolios of a wide range of different options contracts.
All my option trades are limit orders which only execute at my limit price or better.
My guess is that the order books (multiple exchanges) are managed by computers and I don’t see how the computers favor market makers.
The spread is not set by the market makers but by traders. Market makers can narrow the spread to promote trades (their job) but I don’t see how they can widen it. In liquid markets the spread tends to be ten cents. If there is no interest in trading the spread can be anything and market makers are supposed to narrow the spread.
When stocks are in a downtrend there are few call option buyers and prices are low. When stocks are darlings and/or going up option prices are high. Call buyers are gamblers hoping to buy the stock below its market price. That can happen when the stock rises but not when it’s falling in price.
The Captain
When entering a trade, there is a Bid and an ask. For EVERY “buy” or “sell”.
An option chain shows only the bid ask for that specific “leg”.
I look at the chain for the various strikes to see if OI n Volume are “good”, then if yes, I move on to the next step.
@Kingran mentions “roll” several times.
A “Roll” is two (or more) trades at the same time. AKA, multiple “legs”.
The number of legs depends on the complexity of the option strategy being “unwound”.
Each leg has its own bid/ask. And bid/ask spread.
For me, a roll is done inside my brokerage, and shows both legs and the bid ask for each leg.
The “roll” then combines all the bids n asks from all the legs into one (1) hybrid/average bid n ask. For the entire transaction.
This “hybrid/averaged” bid / ask can be “wider” or “narrower” than the individual leg bid/ask.
I “think” each leg is processed separately. And the combined bid ask (of the separate transactions) is presented to the person “rolling” to see if it is acceptable.
FWIW. Please correct any mis conceptions!
ralph
You need to know when to place market vs limit order. Don’t assume limit will get executed. When they don’t get executed… basically you have a situation where you cannot roll…
Not necessarily. I am not sure which brokerage you use, all brokers route their orders to first dark pool and then to exchange. You can actually see which exchange your order got executed. In fact, at IBKR, I actually choose explicitly not to route my order to certain exchanges… because of their execution policies.
Typically, this is where the market maker comes. Say I have a $TLT spread and want to roll the entire spread, there is actually 4 transactions need to happen, a buy close, sell to close and buy to open and sell to open, each leg has its own bid-ask spread. Therefore I set the price, based on the splitting the spread on all the 4 legs, and the market maker takes the order splits and executes. Some they may have matching buyer/ seller and some they may temporarily hold in their books.
Say for ex: yesterday, I have closed 50 contracts of $APPL $222.5 put and opened $225 next. This is a diagonal. What are the chances that there is a matching buyer and seller on the other side. Not much, because I can see the order book. So clearly the MM takes some of that in their book.
Here is another example… where I rolled $PYPL call, it is a diagonal roll, and the legs are executed at different exchange… yeap, see the difference in commission, my buy to close I got paid $0.89 and for sell to open I paid $3.14.
Thanks for the explanation.
I use Schwab. (Not TOS).
I don’t watch which exchange or dark pool processes the transactions or who is on the other side. Sometimes the “other side” is multiple entities.
I care about getting the premium I determined was acceptable to me. The “other side” can worry about their “stuff”.
Where are you seeing the really wide bid ask that is the question of this topic?
At the individual leg, or for the combined average of all legs?
ralph
Of course I don’t assume limit orders will get executed. Preventing unwanted execution is the point of the limit.
After reading all the posts in the thread, I guess I don’t roll, I take the stairs up or down. When I “roll” I execute each “leg” separately.
After studying all I could about options I found that many of the positions one could take were too complicated to understand. I also found that puts were too risky. I also found that it is vital to understand the underlying stocks. Now all I do with options is to sell and manage covered calls plain and simple.
Why would anyone care about the other side? Trades either execute or they don’t. The actual other side in option trading are the underlying stocks, what will they do if you are stuck with them?
The Captain
All US listed options must be executed on an exchange.
There may be exceptions for a process in which large dealers can trade large quantities directly against each other but the trade would still get reported on the exchange (not 100% clear on this, but pretty sure something like this exists).
Volume is dominated by MMs. Retail traders will not be trading against each other the vast majority of times, probably not even for the most liquid options.
Computers per se may not favor MMs, but the process of bringing a trade to the exchange and executing it might favor MMs (and probably does).
There is a kind of auction process that happens but the specific fee structure and process probably favors MMs.
Some of the links in the post below have more detail. But it is an opaque (usually a bad sign) market and difficult to find good, publicly available explanations on how it works exactly.
Suppose you go to a casino, who are you gambling against? Mostly against the odds of the game, not the gambler next to you. When you sell a covered call, who are you gambling against?
I find the casino model most helpful in selling covered calls, it simplifies not having to worry about MMs, etc., etc., etc. Just find the best call to sell. Same with my version of rolling. KISS!
The difficulty is finding that “best” call to sell. I have not seen any app advertised to do it. Starting from a very simple spreadsheet, going to more complex spreadsheets, I wound up writing a Covered Call Option web app. It finds not only the best call in an option chain but across option chains. Later I followed up with a Roll Selector. I execute the “rolls” one leg at a time. Then I learned to roll both up and down which allowed me to use all the stocks in the portfolio to sell covered calls. All else, except stock picking, is basically unnecessary noise.
This is how I play the game.
The Captain
When I use the word “against,” I don’t mean it in a competitive sense in which one party wins at the other’s expense.
I simply meant what party is very likely on the other side of a retail option trade. Nothing more.
Both parties can win. The business of market making would be pretty terrible if their economic outcome depended on the outcome of every one of their counterparties.
Does it matter?
Exchanges are in the business of trading and they promote market making to goose their businesses. Market making is a business expense.
The Captain
This is a fallacy. I understand it, but still not fully able to shake it. When you are trading options on Crypto, metals, ETF’s, all I am focused on is the momentum, my overall view of whether I am bullish or not, and then structure the trade.
Sometimes, you have to act, not wait to understand the underlying. Recent example is $UNH. I saw clearly the flow is changing, but, I sold puts instead of going long. Same with a crypto name.
Many of us started with stock investing and moved to options. But we are failing to recognize they are two different games. Uncertainty exists in both and our understandings are actually lot less than we give credit to ourselves. So the approach in option trading is, choose strategies where you can limit your risk by choosing how much max money you can lose. That is the day you mature from put seller to call buyer in simple terms.
Another difficult concept I am trying to learn is, “don’t worry about losing trades, focus on the winning trades and see whether you are making enough/ maximum profits on those trades. Just accept the losses, close them. You don’t have to make money on every trade”
Ex: I had a $IWM ratio spread of long 10 Sep $230 and short 20 Sep 250; My cost basis was $2.35 and I had a limit close order for $5. I set this up expecting post Jackson Hole the stock might rip up… but was too defensive. That’s $1500 profit I left on the table for EOD closing and there is potential for further run up between now and Sep19th.
This is one of the main reasons I want to reduce number of trades so that I can focus better and be clear on my goals.
Yes, momentum is key to timing option trades.
I play both and sometimes I wonder if I should just trade options. The sticking point is Tesla, the best investment opportunity I have ever encountered. Better said, the best opportunity I have recognized and be willing to endure the volatility.
My latest maneuver is to sell covered calls on TSLA with a view of not being called. While the premiums are lower they still are better than on most stocks. A nice income stream. Maybe PLTR should get the same treatment.
The Captain
I am clear on this. I have a trading account and the rest are investment accounts. I may sell some covered calls, call spread or occasional puts, but investment accounts are not option heavy. The primary gains are made by long stocks. Options generate short-term gains and stocks generate long-term gains. So that creates some challenges.
My trading account, is option heavy, everything goes here, and it is in some ways my lab to test various ideas and stock holdings.
This fact has been quite annoying to me! Let the darn things trade in increments of a penny like most other things do at this point.
I’ve noticed this happening on the “last day”, especially the last few hours of trading. Because of that, I don’t wait until the last day anymore to roll, instead I roll midweek, maybe Tuesday or Wednesday (or Thursday if I forget). I pretty much only trade monthlies because I like the better liquidity overall and because the market makers mostly treat those as “standard” while they sometimes treat the weeklies as “special”.
Maybe the wide spreads indicate that they aren’t willing to hand out “free money” near expiry. Too many people think that when they sell out of the money options near expiry that it is “free money”, but it isn’t. That’s part of why we see record option volume. And people shilling option strategies (like the Najarian brothers with their “It’s not an option” shtick) on the radio, on the internet, etc aren’t helping the situation.
