by Andy Chambers

If you’re inexperienced at trading options, you’ll soon discover that at any time, an option will have three different prices.  Understanding the first of the three prices is easy, it’s the price the last time the option was traded.  We refer to this as ‘Last Price’.  When trading options, the Last Price is of ‘little value’.  One of the most difficult things for inexperienced options traders to get used to is the lack of liquidity in most options.  We’re not referring here to Index options such as the SPX, or the OEX, (which are quite liquid).  What we’re referring to when we say “lack if liquidity”, are options in individual stocks.  There are just too many options to choose from and there are not enough traders in the world to create a liquid market in all of them.  Therefore, when buying (or selling) options, you’ll need to get used to the fact that in most cases, the other side of your trade will be taken by an options ‘specialist’ or ‘market maker’ or just plain and simply, ‘the guy on the floor’.

It’s the job of the options specialist, to allow us to buy (or sell) any option of our choice.  If there happens to be an ‘open order’ placed by another trader that will satisfy the conditions of our purchase, then the specialist merely ‘matches’ the buyer with the seller and his (or her) job is finisher.  However, when this is not the case, it becomes the job of the specialist to take the other side of our trade.

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Obviously, specialists have ‘outlooks’ just like the rest of us, but in their case, their outlook has nothing to do with their reason for taking trades.  They take trades because they’re required to.  Therefore, in order ‘survive’, an options specialist must be allowed a little room to maneuver.  This ‘little room to maneuver’ is reflected in the ‘bid’ and ‘ask’ prices.  There are formulas (which we won’t go into here) that are used to calculate the ‘fair price’ of an option.  Usually, the ‘bid price’ is slightly below the ‘fair price’ and the ‘ask price’ is slightly above. 

If you’re ever tried to sell something such as a car, a house, an old refrigerator, or anything else of value, you’ve had to deal with ‘bid and ask prices’.  Once you’ve made the decision to sell, you begin by establishing a ‘fair price’ for the item and you ‘up it a little’ in order to have room to negotiate.  This price becomes the ‘ask’ price.  As buyers begin to show interest in the item you’re selling, they’ll make certain ‘offers’.  These offers can be referred to as the ‘bid’ prices.  In order for you to eventually sell your item, your ‘ask’ price must match at least one of the of the ‘bid’ prices.  If you’re anxious, you’ll lower the ‘ask’ price, but if what you’re selling is a ‘collectable’, you may be in a position to hold your ground and force the bidders to raise their offering prices.  If your situation is ‘liquid’ (meaning plenty of interested bidders), your item will be sold, but if your situation is not liquid, you could have a ‘stalemate’.