Why are bid/ask spreads so wide on options?
The reason the bid/ask options spread gets wider has to do with how market makers manage trades. Market makers don’t speculate on where a stock price will go. They usually keep the delta of their positions close to zero. They do that throughout the day by trading stock against the options they buy or sell.
How do market makers adjust spread?
As market makers are more willing to bid or offer, there are larger sizes on the spread, and larger volumes can transact without moving the market too much. Market-maker spreads tend to be tighter in more actively traded names, and in those that have more market makers available to make markets.
How does the bid-ask spread work in OTC trading?
In an OTC market it’s the dealers who’ll set the bid-ask spread in a way that keeps the market moving (liquid) and allows them to make a profit. To a trader, the spread is a transactional cost. To the market maker, the spread is profit. A trader (client) pays half of the spread cost on the trade open and the other half is paid on the close.
What does bid size mean in options trading?
The bid size also represents how many contracts the market is willing to buy at the bid price, which can be interpreted as the entire market demand for those contracts. If the bid size is higher than the ask size, then there is more buying demand than selling demand for that particular contract at that price, and vice versa.
What is the difference between bid and ask prices?
The difference between the bid and ask prices is referred to as the bid-ask spread. The bid-ask spread benefits the market maker and represents the market maker’s profit. It is an important factor to take into consideration when trading securities, as it is essentially a hidden cost that is incurred during trading.
Can You middle the market when the spreads are big?
When the spreads are bigger, yes, you can middle the market to some degree at times, but it is debatable whether you could do the same when exiting the position. Most likely it cannot be done, so an option trader needs to make up the difference just to have the position trade at breakeven. In the example above, the bid is 4.20 and the ask is 5.00.