The bid-ask spread is the difference between the prices quoted for an immediate offer and bid. Let's assume we buy an option and it becomes in the money, can we sell it immediately? Sometimes. It depends on how liquid the option is.
We've underlined the Bids and the Asks here on the 46k 31DEC call. The bids are the price people are willing to pay ($4,900), the asks are the price people are willing to sell at ($5,150):
If you had purchased a call at 4k a month ago and wanted to sell it, do you think you will be able to sell quickly at $5,150 where all the other sellers are at? Probably not, because all the buyers want to buy at $4,900.
If you want to sell immediately you are going to have to sell at the bid price ($4,900). You could set an order in the middle somewhere, lets say at $5k and hope a buyer meets you in the middle, but it might take awhile to fill.
The difference between the bid and the ask (5,150-4,900 = $250) is what is known as the Bid-ask spread.
When you sell at the bid price, you are doing what’s called “crossing the spread.” The more volume on the exchange the smaller the spread becomes, inversely, if there is less volume the spread gets wider.
In conclusion, remember these three points:
- You can get in an out of a trade quickly (and for your desired price) if there is more volume.
- You must consider the bid/ask spread when thinking about your P/L.
- Even with small volume you can get out for your desired price if you are patient.
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