One of the very first concepts a financial trader will encounter is that of the bid and ask price. Bid vs ask in options (as in any asset trading) highlights the prices buyers and sellers agree upon. We’ll begin with a theoretical approach and then show you how bid-ask in options can greatly impact your trade execution and profitability.
Key takeaways
- Bid vs ask in options represent the highest price a buyer is willing to pay and the lowest price a seller is willing to accept. This is true for any asset you trade, even outside the options market.
- The bid and ask price can significantly affect the execution and profitability of options trades.
What Are Bid and Ask in Options?
Let’s start from the basic idea: the bid vs ask refers to two key prices. The bid price is the highest amount a buyer is willing to pay, while the ask price is the lowest amount a seller is willing to accept.
The concept of bid-ask in options is crucial as it affects the cost of getting into and out of trades. These prices are not arbitrary; they are influenced by various factors, including supply and demand, and are shaped by market participants like brokers, investors, and market makers. These participants play a significant role in setting the bid and ask price by:
- Brokers: Facilitate trades and may provide liquidity to maintain fair bid and ask spreads.
- Investors: Their buy and sell actions influence demand and supply, impacting bid and ask.
- Market Makers: Provide liquidity by constantly quoting both bid and ask prices, aiming to profit from the spread.
Understanding what bid and ask are in options helps traders make informed decisions. A narrow spread might indicate a liquid market, while a wider spread could suggest less interest or higher volatility.
Adjusting Bid and Ask Price when Trading Options
Let’s now move from theory to practice and explore how adjusting the bid vs ask in options can influence your trading outcomes significantly.
Why Should You Adjust Bid vs Ask in Options?
Adjusting bid and ask prices is a strategic decision that can improve trade execution and manage slippage. This adjustment is crucial when market conditions change or when the bid-ask spread widens, making trades based on mid-prices challenging to execute.
- Trade Execution: By tweaking the bid-ask level setting, you can align your trades more closely with current market dynamics. This setting, available on our options screener, allows you to select how option prices are calculated. While the default might use mid-prices for simplicity, volatile markets may require more conservative settings for successful executions.
- Slippage Management: Slippage occurs when a trade is executed at a price different from expected. By adjusting the bid-ask level to a more conservative setting, such as 25% price improvement, you can reduce slippage. This change may result in fewer trades but offers a higher probability of execution at desired prices. When markets are turbulent or bid-ask spreads are wide, using this setting can help streamline trading strategies.
Specifically, in our options market screener, you will be able to edit the bid ask level adjustment for each scan, as you see below:
How does this work, in practice? You can refer to our simple bid-ask level guide and check out a simple example to clarify the aspect.
Real-Market Example of Adjusting the Bid and Ask Price
Consider a practical scenario using a predefined scan like “High Probability Strangles.” Initially, you’ll notice that our scan uses the mid-price to determine the profitability of options strategies.
For instance, if LULU is trading at $291.63, a short strangle might involve selling a $252.5 put and buying a $332.5 call, both expiring in two weeks:
This setup, calculated using mid-prices, might show a maximum profit of $231, with breakeven prices at $250.19 and $334.81, and a 93.08% chance of maximum profit.
Now, if you choose a more cautious route and adjust the bid-ask level setting to “conservative,” the screener will consider only the actual bid and ask values, not mid-prices. This approach can reveal different trading opportunities.
For example, the revised setup may involve options expiring in three weeks, with altered strike prices like a $260 put and a $335 call:
This change might lower your maximum profit to $208, with new breakeven prices at $257.92 and $337.08, and an adjusted probability of max profit at 82.91%.
Remember, this probability is theoretical and doesn’t account for unexpected events like significant news affecting LULU’s price. It’s crucial to base your trades not solely on mathematical probabilities but to also consider company fundamentals and other technical indicators. Adjusting the bid vs ask in options helps you stay adaptable, making calculated decisions in a dynamic market.