The market has certainly been on a mission lately, moving higher over the past several weeks after a big decline. In addition, implied volatility (IV) levels have continued to drop after spiking higher for a few days. That is not a good thing for option traders who love to sell premium. But the good news is that bid-ask spreads tend to be tighter when options are cheaper. What, you never worry about bid-ask spreads? If that is the case, you should definitely read on.
What Is Not to Like?
If you are cognizant of bid-ask spreads tightening up, that is a good thing. If you don’t generally think about them, it is time to take notice. Option traders need to be aware that there are still plenty of stocks and ETFs that have wide bid-ask spreads, and what you don’t know or realize is that they can really hurt you. Let me show you why.
What to Notice
Take a look below at this recent call option chain of the Alliant Energy Corp. (LNT) with the underlying trading at the time of this writing around $57.50.
The bid price for the 57.5 Sep-20 call is 1.00 and the ask price is 1.40. That is a 0.40 (1.40 – 1) 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 to exit the position at the mid-price too. And sometimes, especially if the option goes deeper in-the-money (ITM) or further out-of-the-money (OTM), the bid-ask spread gets even worse if you can believe it. Look at the 55 Sep-20 call above. Its spread is 2.20 (5.10 – 2.90) wide. The 0.40 wide bid-ask seemed relatively innocent, but look what could happen if the option went deeper ITM.
Final Thoughts
If you have ever seen me teach MTM’s Group Coaching class, you know I am extra aware of wide bid-ask spreads. I will turn away from what I deem a good probability trade idea if I think the spreads are too far apart. I am not saying you must be as strict as me, but you need to be aware of bid-ask spreads. Why would you want to put yourself into a bigger hole than you need to when entering a trade?
