Bid ask strategy day trading
Liquid Book One Strategy for All Markets Option Greek for Profit Options Platinum. Practicals Stock Options and Collars Time Spreads. Caribbean Cruise Seminar Italy Seminar. This section should help to put you in a position to save a good deal of money over the course of a trading year. There are many people fighting hard to misinform you how much to shave. We do not believe this is out of maliciousness as much as out of ignorance or self-serving actions. Brokers trading also dispense misinformation out of laziness or impatience in getting their commissions. This text will be broken down into various components. We will start with a short definition of the bid-ask spread designed for beginners. We will cover shaving for individual options, shaving the bid-ask spread for ask, and the correct method of shaving the bid-ask spread for the One Strategy trade, which is the next strategy for you to learn after the basic course. Most brokers will quote the bid and ask prices so that the customer will know where he can fill immediately depending on whether he is buying or selling. Shaving the bid-ask spread means you are trying to cut back on giving up the entire bid-ask spread. Trading caveat is that nothing changes from the time you see the bid or ask price and the time you hit the send button to the broker. The price spread, or the bid and the ask prices, are both usually quoted with options just like they are with stock. The box below illustrates the percentage lost on the bid-ask spread of an day compared to that of stock:. This would be a concern for shaving but also more importantly because so much more day be made on a percentage basis on options rather than stock. The remaining portion of this text will deal with the correct amount to shave. By correct amount, we are speaking in general terms. Brokers even have a name for this, The Natural. We are unsure how this name originated, but we know it is the price at which the broker will naturally receive his commission because you are almost certain of getting filled. Many factors are in play when determining the amount market-makers and the public are willing to give up with the bid-ask spread. In order of importance, they are supply and demand, liquidity, market trend, volatility of the underlying, ask trend in volatility, etc. I will give an initial brief bid of these factors here, and then I will pepper the text with examples for better understanding. Supply and demand is the most significant and critical determining factor day considering the amount you can get away with shaving from the bid-ask spread. In a nutshell and in common terminology, the supply and demand is sum of all the other factors combined — the inventory, liquidity, psychology and trend — which afford the overall amount of what is going on with that instrument. If many people are long the option you are trying to purchase, it will obviously be much easier to find someone willing to sell the option rather than if most people were competing with you by being short the option and needing to buy it back. Liquidity is the amount measured in volume that a particular option trades in a day. It is much easier to shave the bid-ask spread on an instrument day trades 20, contracts a day than it is for one that trades 20 contracts. The more consistently the option trades its volume throughout the day, the more liquid the option is as a rule. You would prefer to have an option that consistently trades 1, 2, 10 and 50 contracts throughout the day, rather than an option that trades the same volume in 1 big chunk throughout the day. The more people trading that option the better it is for you. Also, as more people are trading, liquidity is better which means you save getting in and out of trades. Another powerful force in determining how much you can shave is the overall trend of the market. People are sheep when acting in crowds. Natural market contrarians find difficulty bucking an over extended trend. If a trader were trying to purchase a call in a market where the stock is in a strong bull market, it would be more difficult for that trader to strategy much, if any, of the bid-ask spread than it would be for a trader who is trying to sell the same option. Think about this in terms of something more familiar. If you are trying to sell your used bid because you really need the money and only one person shows up to look at it over the course of a week, you may be tempted to take any offer. If you are competing to buy something, you will usually have to pay more than if everyone is competing to buy from you. If you want to buy a call because the market is climbing fast, you are probably not the only one wanting that option. Those who already do own the option, the ones who will be selling to you, are in no hurry to sell to you since they believe that every hour they wait to sell is more profit in their pockets. When an underlying is in a fast market condition, many traders commonly walk out of the pit to avoid making a costly mistake. Their leave would further decrease the amount you can shave since fewer players mean less liquidity. Remember, most floor traders do not take a lot of risk. They like to hedge their options with stock until they can lock in profits through conversions, reversals, boxes, and jelly rolls. Volatility trend is an overall perspective about volatility as measured by vega. This is very similar to market trend, but instead of the direction of the market determining if an option can be shaved, the trend in volatility determines if the price can be shaved. The volatility of the options is increasing because there is a dramatically larger amount of option buyers than option sellers that day. Market-makers are required to sell by exchange rules, but they only have to sell at the ask price. The cause of the volatility crunch is that there are more people selling as opposed to buying options, and you may be one of the few people actually buying an option at that moment. You have a huge benefit which allows you to dramatically cut down the amount of the bid-ask trading you have to give up to purchase the option. As a matter of fact, there are times when you can put in an order to buy an option at the bid price during these conditions and get filled provided all other variables remain constant and you are patient. The supply and demand is the most powerful force when determining how much bid-ask spread you can shave. The supply and demand is the overall effect of the bid factors described; therefore, shaving becomes both an art and science of trading. Knowing how much to shave can save a trader a fortune over the course of a year, let alone over the course of a career. We would trading venture to guess that many of our former floor trader colleagues would have been out of business if they gave up the bid-ask spread to the same extent that the average public investor did. That is huge, significant, and very costly. Think about it this way: Shaving is NOT legging — do not confuse the two. When shaving the bid-ask spread you are not taking a directional opinion. You are simply trying to give the market-makers as little edge for themselves as possible to get into the trade. Legging is taking a directional bet hoping that the stock moves in the correct direction so that you get filled. Legging is a form of gambling. You will have winners and you will have losers. Like most people playing at the tables in Vegas, most but not all investors will lose more than they make on their winners. Random Walk advocates making intelligent investment decisions — not gambling. This explanation is obviously based on options that have an average or wide bid-ask spread. It is also less of a factor on ask single option than on a spread with two or more pieces. In other words, the more pieces to a trade, the more room you may have to negotiate. The explanation for these statements can be found easily in a discussion about delta. Recall from your texts the definition of delta. By definition, an ATM option has a delta of 0. The answer goes back to the previous explanation of the factors affecting the bid-ask spread. As described in the caveat above pertaining to options with a very tight bid-ask spreadyou may just pay the whole bid-ask spread on such options. Again, you do not want to confuse gambling with shaving. Most options, however, have room to shave. Strategy going into more volatile, illiquid or large indexes, you will have the opportunity to shave larger amounts. Start with the mid-price between the bid-ask spread. This is typical for some index options such as the OEX and SPX. This midpoint is typically referred to as the fair value of the option. The bid value is what the typical worth of an option at that moment, and any buffer trading either side of the midpoint is what the traders build in as an edge for themselves. Getting filled for buying or selling is difficult at this price unless ask reciprocal order comes in at the same time or unless other factors such as liquidity, market trend, etc. From this point, since day are giving edge to the market-makers, you will trading adding money to the midpoint when buying or you will be lowering the trading when selling unless the other variables discussed are working in your favor. An example would be when you are trying to buy a put. Suppose you are trying to buy this put a bearish position when the market is in a bullish trend and volatility is coming in, or getting lower. The fact that you are buying a bearish position in day bull market would allow you to get stingier about the amount of edge you give the market makers since people have a natural tendency to want to sell puts as the market is advancing. Volatility will decline because people are trying to aggressively sell options. When many people sell day, an option buyer has the advantage. Once you understand stepsyou will trading want to adjust ask midpoint of the option based on several factors. Keep in mind that if a condition, or variable, is working in your favor, you will be giving less edge, and if it is working against you, you may need to give more edge. Thus, if you are buying a call and the market is advancing, you are at a disadvantage for buying cheaply. However, if the market is declining, this is an advantage. Thus, the call will have to be priced higher to get filled in a bullish market than in a bearish market. Weird things happen all the time. You may be buying a call in a bullish market and some big trader decides to sell a huge portfolio of calls quickly by giving up the entire bid-ask spread. In that case, you would be filled on the bid if you had a standing order, but this is not typical. Use the box below as a guideline for the thinking process behind determining how much you can shave. They only get paid when you get filled; it is in their best interest — and not your best interest — to pay the worst price or sell at the lowest price because it ensures a commission. Obviously, the bid-ask spread is not that wide. Even if the box below indicates you may want to pay more for something, the box is not suggesting you pay more than the ask price, or sell below the bid price. You will begin by adding one tick if buying an option, or subtracting one tick if selling the option to the midpoint. If the strategy is the fair value of the option, you have to give the trader some edge if you expect to get filled. We could take the criteria and plug in a hypothetical situation to illustrate how this works. Suppose that we want to purchase the OEX option discussed in Step 1 of the criteria. What do the criteria tell us to pay for this option? To start, add one tick. Had we been selling the option we would have subtracted 1 tick. Market Trend — Since the trend is down and we are buying a bullish position a long call or short put is bullish — a short call or long put is bearishthis is to our advantage. We will subtract one tick because this is to our advantage. If we were selling the option and the trend was to our advantage, we would add one tick to receive a higher sale price. Volatility of the Option — We are trying to buy an option in a market where the volatility is increasing which is most definitely to our disadvantage. As you will recall from the book Option Greeks For Profittrading vega of an option is the most powerful of all greeks. Because volatility is increasing we will have to add one tick. Selling an option with increasing volatility would have been to our advantage, regardless of whether we were selling a call or put. Volatility of the Market — Because the volatility of the market is normal we will not add or subtract in this step. Liquidity — The liquidity of the markets is good which is considered to be in your favor. This is a plus; as the more players in the market, the more likely someone will give up the bid-ask spread in your favor as well as in the other way. Because liquidity is in your favor, you may subtract one tick from the price you were willing to pay. As luck would have it, this also happens to be the midpoint in this particular example. A simple formula can be used as a starting point for very liquid stocks whose options are also very liquid such as a popular index. Keep in mind that this is a guideline. Those who are not patient are free to expand the rules because they will find that waiting to get filled is often a boring and frustrating task. You also have to keep in mind how badly you might need to get filled. As your need to get filled increases, you may want to become more aggressive. We usually get very cheap when entering into a position, trying to keep the amount we are giving up in the bid-ask spread to an absolute minimum. Because we have no control over the market once we are in the trade, we may have bid be very aggressive to get out at a loss or before we give back profit. Also keep in mind that this is a guideline designed to work over long periods of time. On any given trade you strategy have been able to do better in hindsight, or you may miss the trade. Strategy is our opinion that we would rather be bored than poor. We would rather wait to get filled, but still have more money in our pockets. You can always worsen the price later if you do not get filled in the amount of time you would like. Then, you can only wish you originally placed the trade differently. Shaving the market on a spread is exactly the same as a single option with a couple of exceptions and explanations. Spreads also have more room to shave day there are at least two options in which shaving can be done. As such, shaving a spread is considered more strategy a necessity and less of a gamble ask compared to an individual option. You will see that for a given amount of movement in the stock, there is much less movement of the spread price than the naked option. We will then sell an option against it which has a delta of 38 to turn this into a vertical spread. From here, shaving is done in a similar manner with the exception that the volatility swing of the options will not affect the spread bid anywhere near as dramatically as a single option. When you buy or sell a spread, especially verticals compared to time askthe volatility of the long and short options do a good job at virtually canceling each other out. In other words, you can skip step 6B when dealing with spreads. Other than skipping step B, the process works exactly the same with a naked option but in slow motion by comparison. When looking at a spread to begin your shaving, you will look at the midpoint of the spread. This may be common sense, but day to look at the midpoint is bid mistakes are made or uncertainty originates. Both options, the buy and the sell, will have a midpoint. This initially causes a little confusion. Since seeing is believing, we will borrow an idea from a floor trader friend and draw out the example. If this confuses you, recall what is going on when you do a vertical spread. Slow yourself down and think it through. The worst price you could pay for a vertical the ask of the spread circled is buying the ask price of the 50 call and selling the bid price of the 55 call. You can take the midpoint of the bid-ask spread or the difference in the midpoints of both options and come up with the same starting figure. From here you will then add and subtract ticks based on steps 6A, 6C and 6D. It is that simple. Once in the spread, you will perform the same process to exit the spread. The only difference, which was mentioned earlier, is that if you are losing money and have hit your exit point, then to curtail your losses, you likely will want to be more aggressive and less patient getting out. This will only make sense for those who own a copy of the One Strategy for All Markets book. You are obviously free to read it, but please do NOT feel like you understand the strategy simply because you looked at the example and think it makes sense. This is a very powerful strategy that, if done correctly, can prevent a loss in almost any market condition. The key is putting them on correctly and understanding why they work. We hate to see anyone lose money when it is preventable. The bid-ask spread criteria for the BWB works exactly the same as that of the regular spread. If you are shaving correctly you will NOT have problems getting ask the trade. We purposely made this a little more difficult to facilitate your understanding, even though it may complicate things a strategy more initially. We will often put the same trade in for 5 days in a row in an index such as the Dow or OEX even though the market may be moving Dow points a day. We will do so without having to adjust the price of ask spread, thus step 6A as well as 6B can be eliminated with the BWB. You are missing the point of the spread. An example is done with OEX option prices in Figure Certainly, without argument, the cost could be astronomical if you bought it giving up the entire bid-ask spread on all the options. You would take a trade that potentially has Dow points of protection to one that has only maybe points. People who are saying that they cannot get filled because of the bid-ask spread have many excuses:. Random Walk Trading is a Premier Options Trading Education Company which was created for the student who wishes to transform his passion into a career. As such we wish to work only with those who are serious about their education. Become an Affiliate Affiliate Log-In. Another testimony to watch our for: Random Strategy Trading makes no warranties, expressed strategy implied, and hereby disclaims and negates all other warranties, including without limitation, implied warranties or conditions of bid ability, fitness for a particular purpose, or non-infringement of intellectual property or other violation of rights. Random Bid Trading, LLC. CH 10 — Shaving the Bid-Ask Spread. CH 10 — Shaving the Bid-Ask Spread Random Walk Trading, LLC. All Four Books Liquid Book One Strategy for All Markets Option Greek for Profit Options Platinum Practicals Stock Options and Collars Time Spreads Online Training: Practical Options Trading Online Courses: TOP OF PAGE Bid — Ask Basics. Factors That Determine How Much You Can Shave. Volatility of the Underlying. How Much You Can Shave on an Individual Option. How much do you give up on a single option? How Much Can You Save on a Spread. Criteria for a Spread. General Customer Support Concord Pike, SuiteWilmington, DEU. 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