Every time you trade options, you encounter the bid-ask spread. This spread represents a real cost that affects your profitability. Understanding how bid-ask spreads work and how to minimize their impact is essential for successful options trading.
What is the Bid-Ask Spread?
The bid-ask spread is the difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask). This gap exists in all markets, but it is particularly important in options trading.
The simple version: The bid is what you get when selling. The ask is what you pay when buying. The spread is the difference between them, and it represents an immediate cost when you trade.
Understanding Bid and Ask
The Bid Price
The bid is the highest price someone is currently willing to pay for the option. If you want to sell immediately, you will receive the bid price.
The Ask Price
The ask (or offer) is the lowest price someone is currently willing to accept to sell the option. If you want to buy immediately, you will pay the ask price.
Bid-Ask Example
AAPL $180 call option shows: Bid: $3.40 | Ask: $3.50
- To buy immediately, you pay $3.50 (the ask)
- To sell immediately, you receive $3.40 (the bid)
- The spread is $0.10 ($3.50 - $3.40)
- If you buy and immediately sell, you lose $0.10 per share ($10 per contract)
Why the Spread Exists
The bid-ask spread exists for several reasons:
1. Market Maker Compensation
Market makers provide liquidity by standing ready to buy and sell. The spread is how they get compensated for this service and for the risk they take.
2. Inventory Risk
Market makers must hold positions temporarily. The spread compensates them for the risk that prices might move against them while they hold inventory.
3. Information Asymmetry
Some traders may have better information. Wider spreads protect market makers from potential losses to informed traders.
Factors That Affect Spread Width
1. Liquidity
The most liquid options have the tightest spreads. Popular stocks like AAPL, SPY, and TSLA typically have penny-wide spreads. Less traded options can have spreads of $0.50 or more.
2. Underlying Stock Price
Higher-priced stocks tend to have wider absolute spreads (though the percentage spread may be similar).
3. Time to Expiration
Options closer to expiration often have tighter spreads. Far-dated options may have wider spreads due to less trading activity.
4. Market Conditions
During volatile markets or low-volume periods, spreads typically widen. Around market open and close, spreads may also be wider.
5. Strike Price Location
At-the-money options usually have the tightest spreads. Deep in-the-money and far out-of-the-money options often have wider spreads.
Spread Comparison
Same stock, different options:
- ATM call: Bid $5.00 / Ask $5.05 (spread: $0.05)
- OTM call: Bid $0.25 / Ask $0.35 (spread: $0.10)
- Deep ITM call: Bid $15.00 / Ask $15.20 (spread: $0.20)
The ATM option has the tightest absolute spread.
The Real Cost of Wide Spreads
Bid-ask spreads represent a real cost that reduces your profits. Consider this example:
Spread Cost Example
You trade an option with a $0.30 spread (Bid: $2.00 / Ask: $2.30).
- You buy at $2.30 ($230 per contract)
- If you sell immediately, you get $2.00 ($200 per contract)
- You lose $30 just from the spread
For this trade to profit, the option must increase by more than $0.30 just to break even on the spread cost.
Percentage Impact
The spread's impact is larger on cheaper options:
- $0.10 spread on a $5.00 option = 2% cost
- $0.10 spread on a $0.50 option = 20% cost
This is why trading very cheap options can be expensive despite the low absolute price.
How to Minimize Spread Costs
1. Trade Liquid Options
Stick to options with high volume and open interest. Popular stocks and ETFs like SPY, QQQ, AAPL, and TSLA have the tightest spreads.
2. Use Limit Orders
Never use market orders for options. Always use limit orders and try to get filled somewhere between the bid and ask.
Limit Order Strategy
Option shows: Bid $3.40 / Ask $3.50
- Instead of paying $3.50 (market order)
- Place a limit order at $3.45 (midpoint)
- You might save $5 per contract
- If not filled, adjust slightly higher
3. Trade During Optimal Hours
Spreads are typically tightest during normal market hours (9:30 AM - 4:00 PM ET), especially mid-morning after the opening volatility settles.
4. Avoid Illiquid Strikes
Choose strikes with good open interest and volume. Avoid deep out-of-the-money or far-dated options unless necessary.
5. Consider the Percentage Cost
Calculate the spread as a percentage of the option price. Avoid options where the spread represents more than 5-10% of the price.
Spreads in Multi-Leg Strategies
When trading spreads, strangles, or other multi-leg strategies, you encounter spreads on each leg. This compounds the cost:
Multi-Leg Spread Cost
Bull call spread with two legs:
- Buy $50 call: Spread $0.10
- Sell $55 call: Spread $0.08
- Total spread cost: $0.18
This is why complex strategies require extra attention to liquidity.
Natural Price vs Net Price
When trading multi-leg strategies, brokers often show both:
- Natural price: Best executable price using bids/asks
- Mid price: Midpoint of the combined spread
Try to get filled closer to the mid price by placing limit orders.
Reading Spread Quality
Evaluate spread quality before trading:
- Excellent: $0.01-$0.05 (penny spreads)
- Good: $0.05-$0.15
- Acceptable: $0.15-$0.30
- Caution: $0.30-$0.50
- Avoid: $0.50+ (unless necessary)
The Mark Price
Brokers often show a "mark" or "mid" price, which is the midpoint between bid and ask. This represents the theoretical fair value and is used for position valuation.
Mark Price = (Bid + Ask) / 2
Your actual fills will be at the bid or ask (or somewhere in between with limit orders), not the mark price.
Common Mistakes with Spreads
- Using market orders: You will always get the worst price
- Ignoring spread costs: They add up over many trades
- Trading illiquid options: Wide spreads kill profitability
- Not checking spread width: Always look before trading
- Being impatient: Rushing to fill instead of working limit orders
Trade Smarter with Better Data
Pro Trader Dashboard shows bid-ask spreads for all your positions. Make informed decisions and minimize trading costs.
Summary
The bid-ask spread is the difference between what buyers pay and sellers receive. It represents a real cost that affects every trade. Minimize spread costs by trading liquid options, using limit orders, trading during normal hours, and avoiding illiquid strikes. Always factor spread costs into your trading decisions.
Ready to learn more? Check out our guide on options volume or learn about open interest.