Option bid-ask Spreads are prohibitive

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21

On weeklies, every day counts!!! The decay on the last day is significant.

I view that differently, I think MM’s are not able to model the risk and price the risk appropriately, hence they are going for a wide range.

Earlier you were trading against Hedge funds, and institutions. Now, retail has entered big time. Also, there are many “services” when they enter a position they completely skew the bid-ask, and MM’s wides their bid-ask to deal with them.

I guess, I have to rethink my option strategies.

22

I sold covered calls yesterday and watched the stock while it meandered up and down hoping it would trigger my limit order.

  • It traded at pennies
  • The bid-ask spread shrank and grew with volatility.
  • As the stock dropped, the market lost interest and the spread grew
  • As the stock recovered the spread shrank until it was around 10 cents (by pennies) dropping to five and growing to well above ten with one or two executions happening
  • As the market approached closing-time and the price approached my limit I dropped the limit by ten cents and my order executed.

I don’t see anything troubling in this market behaviour. Could it be my stock is of no interest to the big guys? Could it be that the troubling trading is about stocks that interest the big guys?

The Captain

23

Exactly! And it’s also significant to the market maker. And the market maker is likely saying “hey, why should I give that guy (you) the extra nickel, dime, or quarter on something that ends in a few hours?” Instead they create wider spreads to discourage the act of rolling to capture that nickel, dime, or quarter.

It’s also important for us to remember that it’s not JUST the market makers that create the spreads. As far as I am aware, best bids and best asks MUST be displayed on exchanges (in a timely manner). If there are people out there, aside from the market makers, that are willing to put a certain bid or a certain ask, and if those spreads are tight, then they will be displayed as tight. And if they are wide, they will be displayed as wide. But just as this is true, the market makers have a much larger effect on bids and asks because many times they are the only bid or ask.

When I sell options, I place an order at my desired price. But I periodically look to see how they are trading, and I’ll look at the level 2 book bids and asks, and sometimes I’ll decide to move my ask by a nickel or a dime. It all depends.

Just as an example, looking at an option I sold a while back, the Berkshire Jan '27 400s. Right now the bid/ask is VERY wide at 9.25/9.75, and the book is very deep at those numbers. It only traded 3 contracts today and nothing is moving. If I wanted to sell some more (I don’t right now), I would have to move the ask down, first to 9.70, but I bet that wouldn’t get any takers. I’d probably have to step all the way down to 9.45 … I’m tempted to do the trade for fun just to check my instincts, LOL (but I won’t because I’d want $15 or so for that options … anchoring is a real thing). As I type this, the bid went up to 9.30, and now 9.40. The book isn’t that deep, but these kinds of long term options (especially on Berkshire) usually aren’t.

I don’t mind the bids and asks meandering, and I don’t even necessarily mind wide spreads when warranted. What I don’t like is “knowing” that I probably could get an execution my lowering my ask by 2 cents, but being forced to lower it by 5 cents.

[EDIT: Now the spread on that option is 9.35/9.90, still very wide. No new trades of course.]

24

This is a myth. As an individual investor, you will not be able to constantly adjust the bid-ask as the stock price bounce. You can place a limit order then that contract is much further away from the current quote.

25

My broker, Lightspeed, caters to traders and displays the running bid-ask quotes on the option ticket as well as on the orders page and the option chains.

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Depends on the broker, With Lightspeed I can rise or lower the limit by 5 or 10 cents (or whatever I set that option to) with just a few clicks.

The Captain

26

Of course I can! I do it all the time. If I definitely want an execution, I will drop the ask by a penny (or a nickel if I am forced to) so I can be the best ask. Then I see MY ASK as the ask price. And if someone else undercuts me and drops it further, I might drop mine even further, and instantly see MY ASK as the new ask price. Have you never done that yourself???

And sometimes (rarely) if I want to grow a position, I’ll even have multiple asks out there, that way I might snag the first few options at one price, but as soon as my trade happens, the next ask (or bid as the case may be) might also be mine. That’s how I split the difference sometimes with nickel increments. I might sell the first set at 9.70 after dropping down to 9.70, but then my 9.75 ask takes over and I might get 9.75 for the second set. So my average price will be about 9.725. But really I do this mostly for fun, because it doesn’t really matter much if I get 9.70 or 9.75 for the whole trade, but it keeps it interesting this way. Once, a while back, when buying some options, I had 5 or 6 different orders out there at bids every 5 cents. I do NOT advise doing this because if the stock price suddenly moves against you, they may all execute at once, and that may not have been your intention.

I’d guess that all modern brokerages do so.

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27

I don’t know if this directly impacts what you are discussing, but my understanding is in the US, for options, there are two common paths.

  1. Customer facing retail broker hands customer order to market maker (who may pay the broker for the order: “payment for order flow”) who then takes order to the exchange (and then there can be something called a “price improvement auction”).
  2. Customer facing retail broker takes customer order to the exchange.

I think #1 is more common.

Your broker will have disclosures on this.

28

My broker lets me pick the exchange. I don’t care, I let the broker pick the exchange.

Most of the time my order executes when the bid-ask matches my limit but not always. I attribute the exceptions to orders prior to mine executing but not enough volume to execute mine.

The Captain