John Jagerson

Options Pricing: Bid-Ask Spread

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This article is brought to you by LearningMarkets.com.

Every option has two prices at any time of the trading day.

The first price is called the "bid" or sell price, and it's the price at which you could sell the option.

If you had purchased a call option two weeks ago and were now ready to sell it back for a profit, you would look at the bid price.

The second price is the "ask" or buy price. That is the price at which you can buy an option.

Let's say you wanted to buy a put option on Google (GOOG) today, and wanted to know what option investors were paying for that put right now. You would simply look at the ask price. The ask price is always higher than the bid price.

Bid-Ask Spread

The difference between the bid and ask price is the "spread."

Imagine that the current ask price for a put is $1 per share, and the current bid price is 90 cents per share. In this case the spread is 10 cents.

Ask Price: $1 per share
- Bid Price: 90 cents
= Spread: 10 cents

What this means is that when you buy the option you immediately incur a small loss, because you paid $1 and can currently only sell it for 90 cents a share. So you need the option to appreciate in value before you can get to a breakeven point and then profitability. The spread is a major component of trading costs.

In this video, we will talk about some simple rules and ideas for minimizing the effect of the spread. This will include a discussion about the advantages of longer-term investing, and how to find options with penny spreads.