What a Wide Spread Really Costs You
Run twenty round trips through a wide spread and a tight one, and compare the damage.
Worth reading first: Reading an Option Chain Without Getting Lost
Course catalogue99 lessons
The bid-ask spread is the dullest cost in options and one of the biggest. It is not on any commission schedule, your broker never itemises it, and you pay it twice on every position you open and close.
Over a year of premium selling it can take a fifth of your income without you noticing. Here is what that looks like with the numbers in front of you.
Twenty round trips, two different chains
Set a spread width and a fill style, then see what a year of trading gives away. The stock, the strategy and the risk are identical in every configuration.
Bid $1.95 · Ask $2.05
Filling at the mid means meeting in the middle. You give up half the spread each way. It is not guaranteed, but on a liquid chain it usually fills.
Two prices, always
An option does not have one price. It has two. The bid is the best price anyone will pay right now. The ask is the best price anyone will sell at. You sell into the bid and buy at the ask, so the market keeps the difference.
Spread = ask − bid · Mid = (ask + bid) ÷ 2The mid is a convenience. It is where the two sides might meet, not a price anyone has offered.
On a heavily traded chain like a large ETF, the spread might be a penny or two. On a thin strike of a small company it can be a dollar, which is half the value of the contract.
Paying it twice
This is the part that catches people out. A premium seller does not pay the spread once. You pay when you sell to open, and again when you buy to close.
| Chain | Bid / Ask | Sold at | Bought at | Round-trip cost |
|---|---|---|---|---|
| Tight | 1.98 / 2.02 | $198 | $202 | $4 |
| Typical | 1.90 / 2.10 | $190 | $210 | $20 |
| Wide | 1.60 / 2.40 | $160 | $240 | $80 |
One contract with a $2.00 mid. Sold to open, bought back at the same mid a month later.
The bottom row is the lesson. The contract was worth $200 either way. On the wide chain the round trip cost $80, which is 40% of the position, and nothing about the risk changed to justify it.
Four numbers that tell you a chain is tradeable
Spread width in cents. Under about $0.05 on a contract worth a couple of dollars is comfortable. Over $0.20 is worth a second look.
Spread as a percentage of the mid. More useful than the raw number. A $0.10 spread is nothing on a $5.00 contract and awful on a $0.40 one. Under 5% is good, over 15% is a problem.
Open interest. Contracts outstanding at that strike. A few hundred is workable. Single digits means you may be the only person who wants it, and getting out will be unpleasant.
Volume. Today's activity. Zero volume with healthy open interest is normal on a quiet day. Zero volume with almost no open interest is a strike to leave alone.
The cost that only shows up on the way out
There is a particular trap here. You can open a position on an illiquid chain without noticing anything wrong. The credit lands and the trade looks fine. The problem shows up when you want out.
If a contract is bid $0.05 and ask $0.45, closing early costs $45 to buy back something worth maybe $0.20. At that point early management is off the table. You cannot take profits and you cannot cut a loser cheaply. You hold to expiration whether or not that is the right call.
Liquidity is not only a cost. It is the ability to change your mind, and it is worth taking slightly less premium to keep it.
Slippage is the same thing, measured differently
Slippage is the gap between the price you planned on and the price you got. Work out an annualised return from the mid, then fill at the bid, and the difference is slippage. It makes every backward-looking number on your dashboard a little too flattering.
The fix is to record what you actually filled at rather than what you meant to. That is the difference between a log that flatters you and one you can learn from.
What can go wrong
Market orders on options. On a thin chain this is how a $200 credit becomes $150 in one click.
Chasing premium onto illiquid names. The extra credit is often smaller than the extra spread you pay to get out.
Working out returns from the mid. Fine for comparing strikes, misleading as a record of what you earned.
Ignoring the exit before you enter. Ask what closing this will cost before you open it, not after it goes wrong.
Key takeaways
- An option has two prices. You sell at the bid and buy at the ask, and the difference is a real cost.
- Premium sellers pay the spread twice: once to open and once to close.
- Judge a spread as a percentage of the contract's price, not in cents.
- Use limit orders. Nothing in premium selling justifies a market order on an option.
- Illiquidity does not just cost money. It takes away your ability to close early, which takes away your ability to manage.
Check your understanding
1. A contract is bid $1.70 / ask $2.30. You sell to open and later buy back at the same quote. What did the spread cost?
2. Which is the better way to judge whether a spread is acceptable?
3. Why does illiquidity restrict your management options?
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