Novice traders are confused to see Bid and Ask when they trade options in their trading account. In this article you will learn what is Bid And Ask Spread In Options Trading.
Ok let me start here. Have you ever walked in a bank and did you see this? USD Sell price and Buy Price? Did you notice that sell price is always higher then buy price? Why because banks cannot make money if they buy and sell USD at the same price.
When a trade is going on in a market place there has to be some kind of negotiation. This depends a lot on supply and demand.
Supply is how many people are willing to sell that stock or option in a market place.
Demand is how many are willing to buy.
If there is a big gap between the supply and demand the spread between the bid and ask will be wider.
If there is not much gap between the supply and demand the spread between the bid and ask will be smaller.
Live Example of Supply and Demand Working
Assume that stock markets are open for trading. There is one stock XYZ which bagged a project worth millions. Obviously the company’s stock demand will increase. Assuming that its price currently is 300 in the market place.
Let us assume that there is just one seller and one buyer for that stock.
Stock at 300. Seller keeps the sell price at 301 in “Limit Order”. When a seller keeps a price to sell he is “Asking” a price to sell. Therefore Sell price is the “ASK” in Ask and Bid.
The buyer sees the Ask price at 301, but wants to negotiate. If he hits “Market Order”, he will get the stock for 301, however he wants to buy thousands of stocks so wants to negotiate the price.
He keeps the buy price at 300.50. Buy price is the “BID” price in Ask and Bid.
If none of them changes their price the stock will not be sold.
However after some time let us assume that some bad news has come in the stock and one more seller pops us and sets the sell price or Ask price at 300.60 (seeing the Bid at 300.50).
Note that the Best Bid and the Best Ask prices are shown to everyone in the market place so that no one is cheated.
After some time another seller pops up and is in a hurry to sell his stocks in panic. He keeps “Market Order” and hits submit. The share gets sold at 300.50 as this was the best BID price at that time in the market.
Hope it is clear now:
1. What is Ask and Bid price.
2. Why there is a difference between Ask and Bid price.
3. The price difference between Ask and Bid price is called the Ask and Bid price spread.
4. The Ask and Bid price spread is wider if traders are less for that stock at that time, and
5. The Ask and Bid price spread is smaller if traders are more for that stock at that time.
Same is applied in derivative (Futures and Options) trading too.
If you have any questions please write in the comments section below.
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