You know how it rolls. You hit a certain age and think back to the old days when times seemed better. Canolis were made with heavy cream (no low-fat allowed). Cool guys drove Camaros or Trans-Ams or maybe even Corvettes, instead of today’s minivans with DVD players in the back. And a Prius? Please. But despite the walk down memory lane, I’ve been a trader for 30 years and I must confess times are better now to trade options.
Consider this. Back then, there were no streaming quotes on computers or mobile phones. Getting trade-execution reports took minutes instead of milliseconds. And market makers like me kept the bid/ask spreads high, wide and handsome. In fact, one of the biggest factors in bid/ask spreads being narrower, or tighter, today is electronic trading.
You want proof? Take a look at SPX options in two expirations—the weekly-expiration options and the options in the regular expiration cycle. The “regular” SPX options are still traded in open outcry at the CBOE. The weekly SPX options are traded electronically, and open outcry in the hybrid system. The weekly and regular expiration options are both cash-settled, are both based on the S&P 500 cash index, and have the same contract size. The only difference is that one is trading only in open outcry, while the other is open outcry plus electronic.
Closing the Gap
Look closely at the bid/ask spreads of both types of options. The bid/ask spreads of the weekly SPX options are narrower. They’re up to 1/2 the width of the spreads of the regular SPX options. The weekly SPX options have spreads .50 wide, while the regular SPX options have spreads over 1.00 wide.
So, why is this? You have to understand how market makers think about bid/ask options spreads. When I was a market maker, a sheet told me the theoretical value of an option for a given index price. I’d look at the index price, look at the theo value, then make a bid price lower than the theoretical value and an ask price higher. That difference around theo value was my “edge.” But if the index changed without me looking, I’d be making a market off an inaccurate theo price. So I made my bid/ask spreads wider to give me room in case the index did move, especially a big index like the SPX. I didn’t want to get picked off by making an inaccurate bid/ask off an old index quote.
But with electronically traded options, computers don’t get caught not looking at the index price. With electronically traded options, the quotes are electronically generated as well. So when the quotes are generated by a computer using an option-pricing model, the quotes can be updated with every tick in the index price. The computers don’t have that problem, and are less concerned about getting picked off. So, their bid/ask spreads can be a bit tighter.
Electronically traded options have been with us for years, and the resulting narrower bid/ask spreads can mean reduced slippage when retail traders like us execute limit orders. The options traded in penny increments wouldn’t be possible without electronic trading. But sometimes you forget how nice it is to trade them and need to be reminded of the way it was in the old days. But I still miss my Trans Am.
You can view all SPX and other Weeklys options under the Trade tab in thinkorswim®. Just enter a symbol in the fill-in box in the upper left, and if they are listed, the Weeklys will show up in the Option Chain in the center of the page.