What has happened over the past couple of months? The market has been crazy and volatile! As an option trader, volatility(NYSEARCA:VXX) can be a very good thing.
In fact, when option prices rise as they have, smart option traders can take advantage of selling expensive premium and gaining extra positive theta due to time decay. Sounds like a win-win situation doesn’t it? Well it can be, but option traders need to be cognizant of something besides increased volatility and expensive options. They need to be aware of larger bid-ask spreads as well.
Take a look at the recent call option chain of Shopify Inc. (SHOP) below.
The bid price for the 460 call is 15.40 and the ask price is 22.30. That is 6.90 (22.30 – 15.40) difference between them. Granted, an option trader can try to middle the market whether buying or selling closer to the mid-price. But it is usually not as easy trying to exit the position at the mid-price too. And sometimes, especially if the option goes deeper in-the-money (ITM), the bid-ask spread gets even worse.
For the example above, the stock was trading around $460. But even less costly stocks have seen their bid-ask spreads swell as well. Below is a recent put option chain of Alcoa Corp. (AA) when the stock was trading around $7.40.
The spread between the bid and ask price is still 0.90 (1.90 – 1) wide. That could be a lot of ground to make up for an option trader just to get back to breakeven on an option trade. Imagine if it was a spread trade and the bid-ask spread became even wider?
Volatility can be a very good thing for option traders. It can create a whole new dynamic as far as option strategies go. But it can also open up what you are paying or receiving for the option when the bid-ask spreads get pushed farther apart. Be careful of those spreads and good luck!