Ken Trester

The Price of Options Trading Success

by Ken Trester   07/16/08

The asking price is always higher than the bid price, which reflects orders at the level where bidders want to purchase the option. It doesn't mean that the order will get filled -- the bidder may have to eventually pay the asking price if no sellers are willing to honor the bid price.

Remember that the bid, the smaller number, is the price at which a market-maker is willing to buy a security from you. And for your selling purposes, you may want to take the highest bid price for which you can sell the option, or else you can try to "ask" for your desired price and see whether anyone bites.

The bid/ask spread is as simple as applying the law of supply and demand. The market-makers want to take more money from you by selling to you at a higher "ask" price, while giving you less money for options you want to unload by buying at a lower "bid" price.

In fact, market-makers make money on the difference between the bid price and the ask price. That difference is called the "spread."

The bid/ask spread, then, represents the highest price a buyer wants to pay for an option and the lowest price a seller is willing to accept for it. The delicate balance of an option's premium always depends on a simple formula: how little the seller will accept and how much the buyer is willing to pay.

Market-makers are the ones who set the width of the spread, so it can be anywhere from a few cents to a few percentage points, depending on the asset's value. These dealers work independently of brokerages and match up buyers and sellers by handling the buy and sell orders. This involves taking on a great deal of risk but serves to ensure that the individual or entity's orders are not only filled, but also protected.

It's always important to keep in mind that there are fundamental differences between stocks and options. Only the stocks that are listed on the Nasdaq (NASD) have bid and ask prices available; stocks on the S&P 500 (SPX) or Dow (DJI) do not. However, all options -- regardless of which index the underlying stock resides on -- are shown with bid and ask prices.