The Option Bid/Ask Spread is the difference between the stock option bid price and the ask price. A nickel wide bid/ask on an option that trades for less than a dollar is considered to be tight. A dime wide bid/ask spread on an option that is $3 or less is considered to be tight. A $.20 bid/ask spread on an option that trades between $5-$7 is considered tight and a stock-option that trades over $10 and has a $.30 bid ask is considered to be tight. The bid/ask spread is important because it impacts the cost of trading options. Wide bid/ask spreads eat into profitability and that cost is called slippage. The underlying stock is always much more active than the options and it will have a very tight bid/ask that is only a few pennies wide. Market Makers spread the option bid/ask as wide as they can because it gives them a larger edge. Option exchanges used to regulate how wide that spread could be, but they no longer enforce those rules. If a stock option is ill liquid and you are compelled to enter a position, make sure the trade is longer-term in nature and buy options with at least four months of life. I also suggest scaling in and scaling out. Be prepared to stick with the position if it moves against you. If you traded a front month option, you would be forced to “roll” the option trade as expiration approaches and you would have to navigate the wide bid/ask. Each time you have to enter and exit the position, you are giving up a huge edge, and your profits are slipping away. I suggest trying to buy an stock option slightly below the ask and I suggest trying to sell a stock option slightly higher than the bid. Market Makers will usually give in a nickel or a dime on a wide market.
Option Bid/Ask Spread
December 2, 2008