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There are a number of factors that determine option bid ask spreads,
however they alll tie into the ability of the floor trader to hedge.
First there are legal limits at every range of prices as set by exchange
rules. In almost all instances these limits can default to the limit
oof the underlying security. So if a stock or basket had a $3 b/a the
option could have a $3 b/a.
B/A's are set by the trading crowd or specialist depending on the
exchange. A limit order could change(improve )the b/a assuming it had
no qualifiers that prohibited it being shown on the screen. For example
an AON to buy 50 contracts could not be shown on the screen because ,
for example, a 10 lot to buy could not be filled by a 50 lot AON.
At almost all exchanges, for almost all options an autoquote system
exists which prices the options and is set to a b/a default with some
parameters.
For example 0 - 3 set at 1/8.....3+ - 5 set at 1/4, above 5 set to
stock b/a or 3/8 whichever is greater.
The b/a is also for a specif size(which varies based on pit culture)but
for no less than 10 contracts. Large orders can, and often will be,
done outside of the b/a.
There are different rules about customer priority. At CBOE we have a
customer orderbook which has priority over all trades except
spreads(which is why trading at a spread as a spread is often
superior(actually abouut 2/3 of the time it is better). So a book limit
could be touched by a spread and the book limit order not trade.
You have a booked limit to by at 2 1/2. A print occurs at 2 1/2 but it
is not you. WHY? It was part of spread and to facilitatre the spread
one side was done at 2 1/2...since the spread is noot sensitive to the
"absolute" value of an option it can touch the bbok on one side.
Thhere is often a pit market better than the screen. Remember if the
pit committment is say 100 contracts they might display a quote which
represents their committment....a better quote might exist for 5's and
10's. This is the kind of activity that has evloved in instruments like
SPX and DJX where the screen quotes are for a size of greater than 10
contracts.
In declared fast markets....BE VERY CAREFUL.....as most ATM and ITM will
default to legal maximums.
Be especially careful of put b/a when markets are down and it becomes
difficullt or impossible to short "listed" stocks. No upticks
essentially means no ability to hedge so...mark the puts up enough to
try to bring in natural sellers. If I can't short stock..I can't build
puts so I only want to sell themm if you make me...and the only way to
make me is to pay up. This by the way is one of the primary reasons for
vol skew. Not the only reason.
I think I got to alll your points or at least I hope so because a finger
I use for typing just fell off.
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