Weekly stock options offer a tremendous amount of opportunity for trading and hedging purposes.
There are literally hundreds of tradable weekly options at your disposal.
How do I narrow them down and focus on the ones that offer me a fair chance at becoming successful?
Simple. I only trade weekly options that offer a competitive bid/ask spread.
Remember, in the open market, there are two prices for an option–the price someone is willing to pay–and the price someone is willing to sell that option.
When the buyer and seller agree on a price, a transaction is made.
I want the difference between the bid and ask price to be tight (not too far apart from each other). By the way, stock option bids and offers can be altered in penny, nickel or dime increments.
Weekly Options Examples:
Facebook (FB) options allow you to adjust your bid or offer in penny increments.
The Priceline Group (PCLN) options allow you to adjust the bid or offer in dime increments.
I bring this up because I’ve heard some traders say that you should stick to trading options where the bid and ask can be adjusted in penny increments because they are competitive.
That’s great advice and can save you a lot of money at the end of the year.
However, focusing just on penny wide spreads will limit your options…….
I want to share with you another approach that will provide you a few more opportunities, while still keeping you out of the bad ones.
How can we tell if a weekly option bid/ask spread is competitive then?
I use a simple but powerfully effective market maker technique. I judge the bid/ask spread by the vega of the option.
Now, this might sound complicated…but it’s really not. Let me show you.
Here is a snapshot an option chain of Apple weeklies (only calls displayed). On my option chain, I have the bid and ask price displayed…along with the vega of the calls (displayed cVega in the image).
OK–so what I’m looking for is the difference between the bid/ask spread to be less than or equal to the vega of the option for it to be labeled a competitive option to trade.
For example, the 615 calls are 4.55b/4.65a…the spread is 10 cents wide– the vega is 29 cents. The vega of this call option is greater than the spread…making this a competitive option to trade.
On the flip side…
If the bid/ask spread is greater than the vega of the option…it is not a competitive option to trade.
Let’s look at some more examples so you can get the hang of this.
Telsa (TSLA) weekly options…the bid/ask spread for the $207.50 calls is 3.60b/3.70a…the vega of the call is $0.10. Again, this is a competitive market. The spread is equal to the vega of the option.
Facebook (FB) options…the bid/ask spread on the $61.5 call is .82b/.84a…the vega is $0.03…again, this another competitive weekly option to trade.
Priceline (PCLN) options….the bid/ask spread on the $1197.50 call is $12.90b/$14.10a…the spread is $1.20 wide…however, the vega on this call is $0.57. This is NOT a competitive weekly option to trade.
Herbalife (HLF) options…the bid ask/spread on the $64 call is $0.76b/$0.97a… the spread is $0.21 wide…the vega on this call is $0.03. This is NOT a competitive weekly option to trade.
Keep in mind that option market dynamics can change. It’s important to constantly check if liquidity conditions worsen or improve.
For example, at the time these snapshots were taken… PCLN and HLF were not competitive options to trade.
However, that doesn’t mean conditions can’t improve at a later date.
By filtering weekly options in this manner, you’re giving yourself a chance to not getting hurt in “slippage.”
Remember, you have to overcome the commissions and the difference between the expected value of the option and the price that you actually execute the order–if the bid/ask spread is not competitive–you’ll get dinged on the way in and out of the trade.
Now, you don’t want a great trade idea to be a loser because you got “chopped up” from the bid/ask spread.
Of course, the better you get at trading–the less you will rely on rules…and the more you will rely on instinct and experience.
However, if you’re not there yet…having a rule of thumb like this… can really help you from making unnecessary mistakes.
By the way, this doesn’t only apply to weekly options…you can use it for standard options as well.
Have you ever gotten into an option trade and ended up losing because the bid/ask spread wasn’t competitive?
If so, I’d like to hear your story.
I’ll be hanging out in the comments section below.