THE BID-ASK SPREAD

First and foremost, we have the calls on the left and the puts on the right. Looking at the calls we have the bid price and the ask price.

Hopefully you know what a bid-ask spread is, but for those that don’t here’s a quick explanation:

The bid price is the highest price the market will currently pay to buy the option. The ask price is the lowest price the market will currently sell the option.

Usually when trading options, you can receive a price close to the mid-point of the spread, but sometimes the market makers will make you pay a little extra or receive a little less.

For example, the July $195 call has a spread of $2.40 – $2.46. The mid-point would be $2.43 but we may not be able to get filled at this price.

If we were buying the call, we might have to pay $2.44 or $2.45 and if we were selling the call we might only get $2.42 or $2.41.

AAPL is a highly liquid stock, so our chances of getting filled near the mid-point is much higher than if we were trading options on a less liquid stock.

VOLUME

Next in the table we have volume. Volume and Open Interest are related but also markedly different. Volume is the number of contracts traded during the day’s session and that balance is wiped clean every day.

Whether a trader is opening (buy to open or sell to open) or closing (buy to close or sell to close), it counts towards that days option volume for that particular expiry and strike price.

Open interest on the other hand is a tally of the total number of option contracts open and active at each strike. This represents all trades that have not been closed or exercised.  The number is only updated at the end of the trading day once all trades have been tallied.

An interesting quirk is that volume can actually be higher in any given day than open interest.

For example, consider this case:

Day 1:  Trader A buys 5 contracts to open. We have daily volume of 5 and have 5 open contracts.

Day 2: Trade A sells his 5 contracts and Trader B buys 20 contracts to open.

On day 2, volume would be 25 and open interest would be 20.

The important thing to note is that trader should focus on options with high volume (liquidity) and open interest.

For example, take this option table on IYT, the Transportation ETF.

It wouldn’t be wise for a trader to open 20 contracts in the 199 calls. Firstly, because the bid-ask spread is quite wide and there is no volume.

But also because this would represent basically all of the options open interest. In this case, the market makers will take advantage of you if you need to close the position in a hurry.

Good luck getting filled at the mid-point on those!

 Related: These 15 Tech IPOs Can Give You Double-Digit Gains!