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What Determines An Option Bid/Ask Spread?

Posted by Pete Stolcers on December 27, 2010

Option Trading Question

Today Rick S. asks, "Why are some option bid/ask spreads a nickel wide and others are fifty cents wide?"

Option Trading Answer

Don’t get me started! For the most part the Specialists, Market Makers and Designated Primary Market Makers determine the spread. I will generically refer to them as DPMs. The title varies from exchange to exchange but the function is the same. They pay membership fees to be able to post option bids and offers. If the option trades actively and the stock is a big cap (GE, MSFT, CSCO) you have a good chance of trading against another trader and the markets are much tighter. As soon as you get off the beaten path just a little, that shifts dramatically.

That’s when the DPM’s are there to “help”. This use to be a manual process and it was handled by a person on the floor. Now everything is electronically quoted, executed and cleared on less liquid issues. The large trading firms (Susquehanna, Timber Hill) have auto-quote systems that determine the bid and ask based on the price of the stock and general option pricing algorithms (Black-Scholes).

I will say that the role of DPM is falling into more and more concentrated hands and that is not healthy. I will also say that I suspect the auto-quotes are less tied to the pricing models than they are to where the other DPM’s have their markets posted. Ever wonder why every exchange ALWAYS has the same bid and ask? Hundreds of millions of dollars spent on programming and their models are identical. Personally, I think it is electronic collusion. To make matters worse, the exchanges have lifted pricing parameters that limited how wide the DPM’s can make their market. The exchanges use to feel that having pricing rules would tighten their markets and attract order flow. Apparently protecting their deep pocket members (DPMs) is much more important. The same DPM often makes markets on same option across different exchanges.

There is also one more thing that auto-quotes base their pricing on - public orders. Yes, they can tell. Every order is designated as retail or firm (institutional).

When the exchanges imposed spread parameters, the price of the option ($1, $3, $5, $8) the bid/ask spread of the underlying and the volume of the underlying were considered. That seemed fair. Now, I’ve seen such wide markets that I’m certain they can do what ever they want. Last month I tried to get out of a call that was ITM a couple of days before expiration and the market was ridiculous. The call was $.80 in the money and the market was $1.20 bid offered at $1.50. The stock had trade 1.2 million shares with an hour left of trading (liquid stock) and that was the best they could do. That is a 25% bid/ask spread and it was shameful. I tried working the order across all exchanges and not one DPM would take me out when I was trying to sell them a nickel higher than the bid. That’s when I called the Options Industry Council (OIC) to voice a complaint and they notified me that - there are no longer spread quoting rules and, “It is what it is.”

To make matters worse, let’s say that I want to make markets and I want to improve the bid/asks as a retail customer. Every time I cancel an order, the exchange charges the brokerage firm $1 if their cancel quota has been exceeded. The brokerage firm then charges me, the trader. A handful of traders like this would put a medium size brokerage firm on the cusp of the exchange cancel quota in a hurry. How can I make a market if I can’t adjust my bid/asks without getting charged? Again, the exchanges are protecting their members. 

This is a very frustrating obstacle to trading options and I will try to give you a few pointers on how to “work an order” in my next posting.

For now, if the spread is too wide, forget the options and trade the stock. Do not leave a live order between the bid/ask in a wide market. If you do, be prepared for the worst fill ever.  You can’t afford to give away that much edge.

I told you not to get me started!

Option Trading Comments

  • On 07/31, Rich Z said:

    I was trying to sell an current month out-of-the money SPX Call credit spread with a limit order placed at what the bid was listed from the brokerage for the spread. It sat for a couple of hours not getting filed, the bid/ask was still quoted the same as when I submitted the trade, so I tried to leg in. I bought the long option at the ask and then went to sell the short with a limit order at the bid and the price dropped like a rock and I never got filled.

  • On 08/01, Pete Stolcers said:

    Hi Richard,<br><br>In that case, you should call the order desk right away and have them status the order on the floor. It should have been electronically matched that instant. Either the order got stuck or the quotes were not updating properly. They always have the ability to represent the order verbally to the crowd and then they can relay the information back. I’m sorry to hear that especially since the market was not moving and you should have been able to get out.<br><br>Pete

  • On 08/01, Rich Z said:

    Let me clear up.. I was trying to sell to open, which would have then made me short the calls.<br>An example is the SPX 1300/1310 call spread was quoted at bid.50/ask.90. I put in a limit order for .50 cents. The SPX 1300 was quoted at 1.50/1.80 and the SPX 1310 was .80/1.00. My spread order sat a while. Then I cancelled order, then bought the SPX 1310 for 1.00 and placed the order to sell SPX 1300 @ 1.50. The bid/ask then dropped to.90/1.20. after an hour and fustrated I then sold my 1310 back for .80 and ate my .20 plus commissions loss. Prices above are not exact but from best memory.

  • On 08/02, Pete Stolcers said:

    Got it. If you see the market there on the screen and you can’t get filled, call the order desk. In this case, it looks like you should have been filled. You were giving up the whole edge on a $.50 wide spread. They will status the order with the floor. That’s their job - make them earn the commission.

  • On 11/15, Igor Goi said:

    Can you explain further “Do not leave a live order between the bid/ask in a wide market. If you do, be prepared for the worst fill ever.”

    What is the risk and what would be a better strategy?

  • On 11/15, Pete Stolcers said:

    You have to decide if you are going to buy it or work it between the bid/ask. In an ill liquid market it is often best to just pay the offer. Again, I have addressed this in this article

    The danger of leaving the order out there is that the Market Maker will wait until the order is just too irresistable to pass up. He knows you have “parked” the order and it is not going anywhere. He also knows that no one else is eyeing it up since there is little liquidity. When the stock moves $2 against you, he will finally take you out. Let’s say the market going in was $5.00 x $6.00 and you place an order to buy at $5.60. Then the stock moves against you and he can’t resist the edge you are giving up so he sells you the options for $5.60. If you were buying calls, he will sell them to you and buy the stock (cheap since it has dropped)to hedge the position. The market comming out is $4.00 x $5.00. Your lonely little order was artificially supporting the bid and he adjusts the market once you are filled. In an instant you are out $1.60 if you were to sell.

    If you work the order, cancel it if it has not been filled in 2-3 minutes. Don’t let them lean on your order.

  • On 04/20, WAYNE WOOD said:

    I’ve had success with trailing - stop orders to sell, so as to protect profits, while “not getting off the train.” My choices in placing the order is to base the stop on the Last, Bid or Ask prices. I understand what these prices are, but what is the best choice ??

  • On 05/01, Pete Stolcers said:

    The stock options are relatively ill liquid and I would suggest using bid or ask on the stock. It will trail much better and most platforms allow this as a choice.

  • On 06/28, Mike Cherry said:

    IF I bot a call to open and then in trying to close out the position sold to open again (instead of sell close) is there a problem ?

  • On 06/30, Pete Stolcers said:

    Your brokerage firm will flatten out the position. If you see it listed twice in your positions, call them and they will take care of it.

  • On 08/26, Steve Place said:

    I’ve got a couple instances where I’ve traded moderately liquid markets with a large spread. I’ll watch the market depth on ToS when I enter my order just above the bid, and then immediately afterwards two other exchanges put 10 lot orders in at my price, effectively eliminating my chances to get filled unless the price goes the way I want it. It’s frustrating, but it is what it is.

    I’ve also witnessed a trader try and put in a large order for XOM puts, and the market maker kept playing around with the bid/ask and the underlying so that it wouldn’t get filled. He had to stay agile and finally beat out the maker once demand ran out.

  • On 08/27, Pete Stolcers said:

    Exactly! I traded against Market Makers and I exploited their auto-quote deficiencies for years. I used a VERY complex software program to identify disparities. As time progressed, their programs became much more dynamic and a few years ago they became very efficient. They absolutely adjust their market based on other orders and they will always keep the upper hand. This is why it is important to use a broker who allows you to preference the exchange. If one Market Maker group wants to play games, you can go to another exchange. If you cancel and replace the same order on the same exchange, they know they have you. A limit order that sits idle is dead meat to them. They know they can wait for the underlying to move and fill you when it is to their utmost advantage.

  • On 10/31, Wayne said:

    I may be exposing my naivete here, but if the option market makers are essentially operating unregulated, can the SEC step in and reform the situation? It seems like the SEC is very strict in other situations (i.e. corporate filing regulations, insider trading situations...) are they more or less turning a blind eye to the options market?

  • On 11/01, Pete Stolcers said:

    Market Makers aren’t really doing anything wrong. They are in the business to make money and without them, there would not be an options market. Regulations would drive some of them away and the liquidity would suffer.

    The point is to protect your order and to watch out for your own interests.

    The one issue I do have is that auto-quote systems are programmed to adjust to one another. After trading against them, I know this to be true. This is electronic “price-fixing” and it should be barred. I know the SEC could prove it.

  • On 11/24, Roger said:

    Which would be better to maximize the gain on an option increasing in value. Using a ‘trailing stop’ which would be entered at the market or a ‘limit stop’ which would be entered at the limit?

  • On 11/25, Pete Stolcers said:

    I wish I had a definitive answer. Every situation is different and each order type has its advantages and disadvantages. Please use the search feature to find articles on stop-limits and trailing stops.

  • On 02/09, Roy said:

    Isn’t sitting on an order until the underlying moves essentially “front running.” Seemss like that should be seriously illegal. Sounds like there are many serious obstacles for non-insiders who want to win in the options markets.

  • On 02/09, Pete Stolcers said:

    This practice is not illegal and Market Makers do it all the time. The key is to actively manage your orders. If the stock has moved and you are not getting filled, cancel the order. If they know it is dead wood and you are not watching it, they will lean on it.

  • On 06/02, carole said:

    I own 1000 shares of a stock that is up 20 points.  My broker had put a ltd call on it at the same strike price for june 20--I don’t know exactly what to do with it and am between brokers

  • On 06/03, Pete Stolcers said:

    I’m sorry I don’t quite understand all of the details from your situation.

    If your account is being transfered (ACAT) to another firm, you are in limbo. You can’t execute trades on those positions while the account is in transfer.

    If you need to protect the position, buy puts on the stock at the new brokerage firm. That will protect you until the stock arrives.

  • On 10/01, Steve Zaslaw said:

    You have discussed not leaving an open bid on an illiquid option. However, my broker’s trading software has an order type called “Peg to stock.” In addition to your bid, you enter the option’s delta. As I understand it, the idea is that your bid adjusts automatically to price movements in the underlying. You can also specify the most and/or least you’re willing to pay for the option. Do you think it’s safe to leave a bid open for an illiquid option with this kind of order?

  • On 10/01, Pete Stolcers said:

    That sounds like a great tool. It must be a staged order because it would require lots of order cancellations. The exchanges charge brokerage firms if they cancel above a certain level. They are simply protecting their members and they don’t want retail customers “making markets”. If you can’t adjust your order, you can’t make a market.

    If this is the case, the disadvantage is that your order never hits the public limit order book and you are never in a position to have you bid or offer hit because it is suspended waiting for a condition to be met.

    Who is your broker? Do you know how the order is represented?

    Thanks for the comment.

  • On 10/01, Steve Zaslaw said:

    Well, I don’t know the technical details you discuss (which probably means I shouldn’t be dabbling in options, but let’s ignore that). My broker is Interactive Brokers (

    For details of how this kind of order is entered, go to and, from the column labeled “Users’ Guides,” download the Trader Workstation (TWS)Printable PDF. ( The “Pegged to Stock” order is on PDF page 166 (which is labeled p. 164).

  • On 11/12, Michael Cohen said:

    Try trading options on the TSX. You want market makers laughing at retail traders? We’ve got stocks that trade five million plus shares/day, and, if you want to open an options contract, you’re the open interest. Lundin Mining, a stock that trades on the OTC market in the States, is one of my favourite examples. Today it traded 5.6 million shares. It closed at $4.33. The December $4 call is bid at $0.40. It’s $0.33 in the money and bid at $0.40. The ask is $0.55. The February $4 call is bid at $0.65. That’s standard on the Montreal Exchange.

  • On 11/13, Pete Stolcers said:

    I understand your frustration - that is a wide market. I know it is just and example, but on a $4 stock, I would just trade the shares anyway.

    Once you get away form the top 100 stocks, the liquidity drops off dramatically in US markets as well.

  • On 12/07, Biggvs said:

    Interactive Brokers offers options limit orders based on IV instead of price. A few times I have used this to buy or sell by giving up only slightly more IV than the market makers. Play their game.

    For example, if the market makers seem to be bidding for calls at 40% IV, I’ll bid with a slightly higher IV. Their bids and my bid adjust automatically to the underlying. When someone comes along willing to sell at market price, I get filled instead of the market makers. That’s the general idea, anyway.

  • On 12/09, josh smythe said:

    I trade commodity options. Usually liquid contracts, ie crude, silver, bp, grains.
    I can try to split the bid/ask but not always successful.
    Are the mm’s the same for stocks and commodities?
    Any advice other than just hitting the bid/ask?
    The spreads on crude for example are wider than the grains.  Thanks Josh

  • On 11/24, need true said:

    I’m outraged. prior to John Deere (DE) 4Q results. I bought a significant amount of DE_Dec_80 Calls. The stock closed on 11/23/2010 at $76.34 whilst the option closed at $1.08
    The next day 11/24/2010, althought DE beat the estimates, I believe the option market makers did everything to keep the stock price down which is probably their right.
    Where i do not agree is that at the open, the stock traded as high as $77.34, well above yesterday close price but the option MM maintained the bid below 80 cents. most of the day, they dropped it below 60 cents. The stock lost just 11 cents (-0.14%) at close whilst the call option lost 54 cents (-50%). This is still the 3rd trading day in the option calendar month.
    Can option MM just set the price as they like? independant of underlaying stock performance?
    I feel some rule have been broken here and would like to file a complaint. I need your opinion on this.
    Best regards

  • On 11/26, Pete Stolcers said:

    As much as you might want to blame someone else for this, you’ll have to chalk it up as a learning experience.

    Before earnings or any other major news event that is planned, the option implied volatilities expand. Option Market Makers do this because there is a chance that a big move will happpen.

    They don’t want to sell options ahead of earnings, but they have to. They build in as much cushion as they can. If you feel the options are overpriced, you are welcome to sell them. Chances are you won’t because the risk is too great. DE could jump $10 after the news and I sure wouldn’t want to short those calls.

    Once the news is out and the market reacts, the options shed implied volatility. The uncertainty is gone.

    Trade options before the event and trade options after the event, but do not hold them over the release of the news. That is a crap shoot.

    What you experienced is perfectly normal.

    Sorry for you loss.

  • On 12/10, e$$$st said:

    I have bought 3 option calls on fto, and the bid / ask is very wide at 4.70/ 6.70, and the stock is trading at 17.00.  if the stock trades higher closer to expiration, wouldn’t i just exercise my right to buy the stock at that time, rather than try to sell the options which have a cruddy bid price?
    thanks, just learning this process

  • On 12/13, Pete said:

    You are exactly right. Aviod the Market Makers and get out using the stock. You would exercise the options and sell the stock to avoid the wide option bid/ask.

  • On 01/24, Frantz B said:

    I have a position in an option. A bad news broke out when the market close. What the best exit for the option? A market order when the market open or a MOO(Market on Open)?

  • On 01/25, Pete Stolcers said:

    I do not like using market orders especially when the stock has major news. I would wait at least 15 minutes after the open and let the stock settle down. Also evaluate the news. If it is merely a downgrade, try to weather the storm. If it is material news that will impact the company long term, don’t wait too long to get out. The decline will likely continue.

  • On 04/14, TheOne Investor said:

    Excellent blog/site. I am learning more about options. I still trade using the ‘guts’ strategy most of the time (and I mean,real guts - not the debit strategy). I am hoping to become better at this and deal more with liquid options like AKAM (made $$), GE (lost twice), LYB - not liquid win and lose both.

    BMY, PFE $$$.  Now I am thinking I will do index options as it is 60/40 long term tax rate!!

  • On 04/15, Pete said:

    One suggestion! Read a few books on option trading and technical analysis. You are currently using the “hope and poke” method. You will learn, but this form of education comes at a much higher cost than a good book.

  • On 04/15, THEONE INVESTOR said:

    Thanks Pete. Yes, I did begin reading a couple of books on Technical Trading (Technical Analysis of the Financial Markets -J Murphy) and also Volatility Edge in Options Trading - Jeff Augen. The second book is a tad advanced for my current strategies, but I also considerably minimize my commissions costs by using free trades. However, I feel that the best money is to made on the bid/ask disparity or market valuation. Still learning, always learning!

  • On 04/20, SteelersFan said:


    I want to take some deep out-of-money puts but am not sure how to structure the buy to my advantage. The bid-Ask is .01 - .05 and I want more than 1,000 contracts. Should I offer a good-till-filled bid with a .02 limit for the entire quantity and hope to get filled? Is it likely to fill or just remain unfilled since it is far below the ask? Would I do better with multiple small buys?

  • On 04/21, Pete Stolcers said:

    First of all, never use terms like take or get in your trading language. If you ever have to deal with a trading desk, they will immediately stop you. Everything is buy or sell.

    From the context of your question, I would assume you want to buy 1000 contracts at $.02. Your only chance of getting filled is to spread 100 contracts across every exchange and to be the bid. As a retail customer, your order will take priority over the Market Makers. You should also make it a GTC order so that you do not lose your standing in the order book. You also need to have retail customers that are long those options and they just want to puke them out for anything they can get.

    No one will ever sell these to you as an opening position. What idiot would sell 1000 option contracts that have unlimited risk for $.02 when they have to put up margin to hold the position?

    Might you ever see this price trade? Maybe in small size a few days before expiration or maybe as part of a spread trade (which you are not entitled to participate in). 

    We’d all love to buy thousands of contracts with unlimited upside and months to expiration for pennies. Who will sell them to us?

  • On 11/11, Al Lange said:


    I just found your site and find it hugely helpful!

    I’m new to options and am confused. How can a stock rise and the call price go down?

    Yesterday I bought - POT Dec 17 2011 50.0 Call @ 1.38. At the time, the stock price was $46.63. Today, the stock is up and the call is $1.02.


  • On 11/12, Pete Stolcers said:

    I would have to see the stock price and options at each snap shot.

    Normally this will happen when implied volatilities drop. For instance after an earnings release or an announced news event. Once the “cat is out of the bag” uncertainty is gone and the risk is reduced.

    It also happens when expiration is approaching. Time decay becomes a factor in the last week. That was not the case here.

    I trade POT and that type of move is not typical. The options are very liquid.

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