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MechTrade
Registered: Oct 2006
Posts: 113 |
11-03-09 04:11 PM
I maintain an EOD database of selected optionable equities.
The main criteria for inclusion into my database include the following:
* Option liquidity and open interest
* Bid/Ask spreads
Since quite a few of you are former MM's, here is the question... how are the bid/ask prices determined?
For example, why does one $50 equity have B/A spreads of $.05 and another $50 equity with similar volumes and Open Interest have a B/A spread of $1.40?
Roughly, my tolerance level for selecting option trades is that I avoid equity options whose B/A spread is more than a nickle per $15 increment in underlying price.
Is there some logic to these large divergences in B/A spreads that an options trader should be aware of?
Mech
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dagnyt
Registered: Nov 2003
Posts: 1773 |
11-03-09 06:33 PM
Quote from MechTrade:
I maintain an EOD database of selected optionable equities.
The main criteria for inclusion into my database include the following:
* Option liquidity and open interest
* Bid/Ask spreads
Since quite a few of you are former MM's, here is the question... how are the bid/ask prices determined?
For example, why does one $50 equity have B/A spreads of $.05 and another $50 equity with similar volumes and Open Interest have a B/A spread of $1.40?
Roughly, my tolerance level for selecting option trades is that I avoid equity options whose B/A spread is more than a nickle per $15 increment in underlying price.
Is there some logic to these large divergences in B/A spreads that an options trader should be aware of?
Mech
EOD data is severely flawed.
Many market makers arrange for the bid/ask spread to widen one minute before the closing bell, making the date less useful to you.
MMs have all sorts of ways to raise and lower bids and offers, tighten and widen markets etc.
When anxious to buy the bids can be raised. Market width is determined by order flow. If pepole are going to hit the bids and take the offers, there is zero incentive to narrow quotes.
When the MMs truly want to trade actively and capture more order flow, they narrow the bid/ask spreads. There is no consistent rule that applies all the time.
Mark
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MechTrade
Registered: Oct 2006
Posts: 113 |
11-03-09 09:15 PM
Quote from dagnyt:
EOD data is severely flawed.
Many market makers arrange for the bid/ask spread to widen one minute before the closing bell, making the date less useful to you.
MMs have all sorts of ways to raise and lower bids and offers, tighten and widen markets etc.
When anxious to buy the bids can be raised. Market width is determined by order flow. If pepole are going to hit the bids and take the offers, there is zero incentive to narrow quotes.
When the MMs truly want to trade actively and capture more order flow, they narrow the bid/ask spreads. There is no consistent rule that applies all the time.
Mark
You completely misunderstood the post.
My EOD database is of the underlying equities, NOT the Options. The data is good.
The B/A spreads I ask about are from LIVE quotes of the Options Chains.
So I repeat... Can anyone explain why the Option B/A spreads are so radically divergent for different underlyings with similar strikes, volumes and open interest.
Don't let the EOD database I mentioned cloud the discussion.
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KINGOFSHORTS
Registered: Sep 2007
Posts: 1460 |
11-03-09 09:50 PM
Quote from MechTrade:
You completely misunderstood the post.
My EOD database is of the underlying equities, NOT the Options. The data is good.
The B/A spreads I ask about are from LIVE quotes of the Options Chains.
So I repeat... Can anyone explain why the Option B/A spreads are so radically divergent for different underlyings with similar strikes, volumes and open interest.
Don't let the EOD database I mentioned cloud the discussion.
Lots of things. (Ambiguous question, Ambiguous answer)
Post some examples next time.
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agy690
Registered: Aug 2009
Posts: 7 |
11-03-09 10:16 PM
I doubt that your EOD is flawed; however Mark is partially right. As an ex CBOE MM i can tell you that is all about open intrest and the bets that the MM's want to make. It is just that simple. They pay for the right to make markets as wide or as narrow as the pit agrees and the CBOE allows. If they are heavy in a pinned strike or need to get out of one leg of a trade, it will most certainly change the B/A spread accordingly.
You can find out through the exchanges the max width of the B/A, I am sure it has changed since I left.
Hope this helps.
AGY/690
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dmo
Registered: Apr 2008
Posts: 781 |
11-03-09 10:36 PM
Quote from MechTrade:
I maintain an EOD database of selected optionable equities.
The main criteria for inclusion into my database include the following:
* Option liquidity and open interest
* Bid/Ask spreads
Since quite a few of you are former MM's, here is the question... how are the bid/ask prices determined?
For example, why does one $50 equity have B/A spreads of $.05 and another $50 equity with similar volumes and Open Interest have a B/A spread of $1.40?
Roughly, my tolerance level for selecting option trades is that I avoid equity options whose B/A spread is more than a nickle per $15 increment in underlying price.
Is there some logic to these large divergences in B/A spreads that an options trader should be aware of?
Mech
Mech, bid/ask prices are not "determined." They just are what they are - the result of a lot of competition between buyers to buy and sellers to sell (tight bid/ask spread), or very little competition between buyers and between sellers (wide bid/ask spread).
Take stock XYZ which has little volume. Let's say that 1000 people around the world are interested in the ATM 105 calls. Of those, the one person who is most anxious to buy those calls is willing to pay 3.10. The one person who is most anxious to sell those calls is willing to sell them at 3.60. De facto, the bid/ask spread on those calls is 3.10 bid at 3.60. Nobody "determined" that, it's just that as it happens, nobody in the world is willing to pay more than 3.10 and nobody is willing to sell them at less than 3.60.
Now take a stock in which there is much more interest, and much more volume, such as SPY. Let's say that the volatility and everything about SPY is exactly the same as XYZ except for one thing - instead of 1000 people worldwide, there are ten million people worldwide actively trading the ATM SPY 105 calls.
With so many more people having their own reasons to want to buy those calls, SOMEBODY is willing to pay 3.35. With so many people wanting to sell those calls, SOMEBODY is willing to sell them at 3.36.
So the tightness of the bid/ask spread is simply a phenomenon that, most of the time, is a function of the volume and interest (liquidity) of that security.
But even if two securities have approximately the same volume and open interest, it could be that at some moment in time nobody is particularly interested in buying and nobody is particularly interested in selling one security, which would cause a wide bid/ask spread. At the same time there may be frenzied emotion surrounding the other security, with a lot of bidders and a lot of offerers, resulting in a tight bid/ask spread.
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