The market has been on a mission moving higher over the past several months, and implied volatility (IV) levels have continued to drop. That is not a good thing for option traders who love to sell premium. But what is good is that the bid/ask spreads tend to be tighter when options are cheaper.
Sounds like a win/win situation, doesn’t it? Well, it can be, but option traders need to be cognizant that there are still plenty of stocks and ETFs that have wide bid/ask spreads. Let me explain.
Take a look at this recent call option chain of the Technology Sector ETF (XLK) with the underlying trading at around $180.
The bid price for the 180 Jul-21 call is 0.92 and the ask price is 2.00. That is a 1.08 (2 – 0.92) difference. Granted, an option trader can try to middle the market whether buying or selling closer to the mid-price. But that said, it is usually not as easy trying to exit the position at the mid-price too. And sometimes, especially if the option goes deeper in the money (ITM), the bid/ask spread gets even worse if you can believe it. Why get “ripped off” so to speak and put yourself in an even deeper hole to try to just get back to breakeven?
For the example above, the stock was trading around $180 when the screenshot was taken. But even less costly stocks have seen their bid/ask spreads swell. Here is a recent put option chain of Beyond Meat Inc. (BYND) when the stock was trading around $16.50.
The spread between the bid and ask price is still 0.43 (2.72 – 2.29) wide. That could be a lot of ground to make up for an option trader just to get back to breakeven on an option trade. And imagine if it was a spread trade and the bid/ask spread became even wider.
Volatility can be a very good thing for option traders. It can open up a whole new dynamic as far as option strategies go. But it can also open up what you are paying or receiving for the option when the bid/ask spreads get pushed farther apart. You don’t want to be that option trader who always funds the market maker’s kid’s college fund, do you?
Senior Options Instructor