Reading the Bid / Ask Spread
Chris Figy

Have you ever placed an order where you received an immediate fill and then thought to yourself that you could have done better? Maybe you could have bid twenty cents less and still received a fill. How about sending an order that you think should get filled right away, but after waiting fifteen minutes or so, you start thinking to yourself: “These floor guys are trying to rip me off.” Well, I’m going to explain how you can read the bid ask spread to help you place efficient orders. This will also give you a little more comfort knowing that you’re placing a good order. Efficient and effective placing of limits is a must if you plan to successfully trade. After all, if we can save on each and every trade, these savings can add up to a sizable reward by years end.
Three Market Types
We start by classifying the bid ask spread into one of three different categories. This analysis helps us to place better orders.
  1. The Screen Driven Market: This is the most common quote. In the absence of any customer orders, what you see is the specialist’s “Driven Market.” The Driven Market is a bid and ask that is driven by a machine around a fair value. The exchange has rules as to how wide the specialist is allowed to set the bid ask spread on an option. Examples of what determines this width are the price level of the option, the time until expiration, and current market conditions. The widths are generally fixed even amounts. For example: All options over fifteen dollars are allowed to have a bid ask spread of two dollars; options between fifteen and five are a dollar fifty wide; and options under five have a dollar wide spread. This is the widest quote that we can expect to see when looking at the bid ask spread.
    Figure 1: Dollar Wide Screen Driven Market

    Dollar Wide Screen Driven market

  2. The One Sided Market: This spread is where a customer’s order is being represented on one side of the bid ask spread. The customer’s order is better than the crowd and has created a lopsided spread. The other side of the market is the screen driven market listed above. Generally, we can spot this market easily once the market moves a bit and then all the bid and ask prices shift. When one price will not move with the rest, this is a sure sign that this is a customer order.
    For example, in Figure 2, we might see all the bids and offers increase by a dime except for the 1450 call offer. If so, this is a sure sign that the forty-one offer is another customer order. We then look to the ask size to see if it also looks like a customer order. Sure enough in this example, there is only one contract offered at 41.00. All the other bid and offer sizes are showing ten contracts. The ten contracts are representing the specialist size on all markets and confirm these spreads are a screen driven market.
    Figure 2: One Sided 1450 Call Market

    One Sided 1450 Call Market

  3. The Two Sided Market: This is a market where there are customer orders on both sides of the market or there is a customer order on one side and the crowd’s best bid or offer is being displayed on the other side. This is sometimes the best market quote, as you might be able to trade this option for fair value or better. This market is often only a dime or two wide. In Figure 3 we have a two sided tight market on the 1470 calls. The 1470 calls have a forty cent wide market verse the 1465 calls with a four dollar wide market. (Quite a difference!)
    Figure 3: Two-Sided 1470 Call Market

    Two-Sided 1470 Call Market

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