Dan Passarelli, CEO - Market Taker Mentoring

I want to start off today's video with a question for you. What is the typical bid ask spread width for the short term within one week to expiration SPY at the money calls? What is the typical bid ask spread width of the short term within one week expiration SPY at the money calls?

Well, I know from looking at it when the market is open, of course they get a little bit wider when the markets closed. But if you look at it when the markets open, they're typically somewhere between maybe $0.02 to $0.05 wide. Okay?

There are times when the market moves a lot when it could be different than that. Take for example, June 15, which was the last Fed announcement. I happened to be sitting in front of my computer, which I usually am, and I was doing my podcast. In five minutes after the announcement, I clicked to record this video. Now take a look at this video.

Notice that the prices of course, are moving around quite a bit because the underlying is moving around quite a bit. Lots of bids and offers are coming in. But if you'll notice the bid ask spreads are quite a bit wider than they typically are. We can see 10, 15 cents and 20 cents, and that's a lot wider than they typically are.

The question is, why are they that much wider? It has a lot to do with volatility. When a market maker buys a call, the first thing they do is they sell short the underlying shares to get delta neutral. And if they sell a call, they buy the number of shares to get delta neutral. So if the underlying stock is moving around very fast, the price might change on them and they might end up getting a very bad fill. So they have to make up for that risk by widening out the bid ask spreads. That's the reason why that happens.

Now, that last Fed announcement, we had maybe about a 2% swing in the SPY underlying shares. But let's go back a few more years, about twelve years earlier, to what became known as the flash crash. That's another time when I happened to be in front of my trading computer. It's kind of a hobby of mine, and I took a screenshot back then.

This is also SPY, and twelve years ago the price was a fair amount lower. This was when the flash crash was going on. I was looking at my screen, I was actually putting together a PowerPoint, and I was like, how can the bid ask spread be like $0.50 wide? $0.80 wide? Looking over here, this is like almost a 1.50 wide, 1.41 wide. How could that be? And then I realized, oh, the price has dropped significantly. The moral to that story is the more volatility there is, the less liquidity there is. Another way of saying that the more volatility in the underlying there is, the wider the bid ask spread in the options.

That's a really helpful little tip that could prevent you from getting into some trouble and getting some bad fills and might even help you to get some even better fills at those moments when you really need it. I hope that helps.