Bid–Ask spread in bitcoin options trading
The bid–ask spread is one of the most important option trading concepts as it can have a significant impact on the cost and the potential profit or loss of a trade.
The bid-ask spread represents the difference between the lowest price that a buyer is willing to pay for a call or a put option (this is called the bid), and the highest price for which an option seller is willing to sell it (the ask).
This means that the bid–ask spread shows us the supply and the demand for an option contract (a call or a put), where bids show the demand, and the asks show the supply.
There are several factors that affect the bid–ask spread of an option contract, such as liquidity, volume, strike price and expiration of an option contract, etc.
Liquidity:
One of the main factors that affects the size of the bid-ask spread in bitcoin options trading is the level of liquidity of the option contract.
High open interest for an option contract means high liquidity as it reflects greater market participation. Also, higher trading volumes for an option contract tend to result in narrower bid-ask spread.
In general, option contracts with high liquidity tend to have a narrower bid-ask spread. This indicates that there are many buyers and sellers willing to trade at similar prices, which makes it easier for you to enter and exit positions at fair market prices.
Illiquid option contracts will have low volumes, low open interest, and a wide bid-ask spread.
Volatility:
In bitcoin options trading, volatility also has an impact on the bid-ask spread, similar to traditional options trading.
When there is high volatility in the bitcoin market, it typically leads to wider bid-ask spreads in options trading. Higher volatility implies greater uncertainty, and potentially bigger price movements, which increases the risk for market participants leading to a wider spread. The wider spread reflects the increased perceived risk and the potential for larger profits or losses.
When volatility decreases in the bitcoin market, it can result in narrower bid-ask spreads for bitcoin options. Lower volatility suggests reduced uncertainty, and smaller potential price movements, leading to a tighter spread. The narrower spread reflects the lower perceived risk of market participants, and the expectation of smaller potential profits or losses.
It’s important to note that the impact of volatility on the bid-ask spread in bitcoin options trading can also be influenced by other factors such as liquidity, trading volume, and the specific options contract being traded. Options with higher liquidity and trading volume tend to have tighter bid-ask spreads, regardless of the level of volatility.
Options Strike Price and Expiration:
Options with strike prices that are deep In The Money (ITM) and closer to the At The Money (ATM) price, typically have the tighter bid-ask spreads, whilst the bid-ask spreads for option contracts with the strike prices farther Out of The Money (OTM) are wider. See picture below:
Similarly, options with longer expiration periods may have wider spreads due to the additional uncertainty that comes with the longer-term option contracts.
Examples:
Let’s review a following scenario where a trader is looking to buy a call option on bitcoin with the $27.000,00 strike price, the bid price of 0.0025 BTC ($67.50), and the ask price of 0.003 BTC ($81.0).
In this example, the bid-ask spread is 0.0005 BTC, or expressed as a percentage 16.67%. If the trader decides to buy the call option at the ask price of 0.0030 BTC, they will incur a cost of 0.0005 BTC.
This 0.0005 BTC (or $13.5) represents the cost of the bid-ask spread, in adition to the transaction costs determined by the exchange. For this trade to be profitable, the bitcoin price would have to jump high above the break-even price.
On the other hand, if a trader wants to sell the call option, with the strike price of $26.750,00, at the best bid price of 0.006 BTC ($160), they will receive 0.0005 BTC, which is $13.36 less than the ask price of 0.0065 BTC ($173.36). This $13.36 represents the potential profit from the bid-ask spread.
Same formula applies for the long and short put, and other more complicated strategies.
These examples are showing us how the bid-ask spread works in bitcoin options trading, and how it can affect both the cost of trading, and the potential PnL of a trade.
How to use the bid-ask spread in your advance:
You can use limit orders to help reduce the impact of the bid-ask spread on your trading. A limit order allows you to specify the maximum price you are willing to pay for an option, which can help to ensure that you are not paying more than the fair market value. The same way you can use limit order to or specify a minimum price for which you are willing to sell the contract.
Another way to reduce the impact of the bid-ask spread is to trade on a more liquid exchange that has a higher volume of options trading activity. As more buyers and sellers are willing to trade, the bid-ask spread tends to decrease, making it easier to enter and exit positions at the fair prices.
It’s important to note that the bid-ask spread can change rapidly as market conditions change, so it’s important that you monitor the bid-ask spread and adjust your options trading strategy accordingly.
Also, keep in mind that the bid-ask spreads can vary depending on the specific option contract, the exchange or market makers involved, and the market conditions (overall market volatility, various events, and announcements) at the time of trading.
You should consider these factors and aim to trade options with narrower bid-ask spreads to minimize costs and enhance your option trading strategies.
Use our tools to play around with different strategies, strike prices and expirations and learn hands on how they affect your potential trades.