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The spreads are basically – here, I’ll give you an example. Remember, if you’re selling an option, you’re going to be selling an option at the bid price. Let’s just take these calls, for a second, on the IWM. When you purchase a call, you’re going to buy it at the ask price. When you’re selling an option, you’re going to sell it at the bid price.
If we’re doing a spread, let’s say we want to do a very simple… Let me take the most basic and simple spread order that you could possibly take. Really, this particular spread, called a vertical spread, is probably the basis of almost every single option trade that you’ll ever make. They are based on this one type of spread, the vertical spread. Almost all the other spreads that we use, including iron condors, calendars, and double calendars – and even double diagonals and some other sophisticated trades, like back ratio spreads – are all just a variation on the vertical spread.
For example, in the Think or Swim platform, we can simply right click on these, and go to “buy vertical.” That will give us our vertical spread. Before I do that, I want to show you exactly what it means to buy a vertical spread.
Let’s say we’re bullish on this particular index, the IWM. We believe it’s going to go up in price. We have a couple of different options available to us. First, we can purchase an outright call. You can see, as I hover my mouse over this, $1.98 price call, which is the June 72 call, I can simply left click on that. It automatically brings up the order entry box, purchasing one of the June 2008 – that’s the date it expires, June of 2008.
The strike price is 72. It’s a call, which means that we will profit if the underlying index goes up in price. For $1.98, which is the current price, and it’s a limit order. In other words, it’s an order where we don’t want to pay more than the $1.98.
Now, if you have, you can set all kinds of different orders, here. You can set market, limit. If you select “Market” and you submit that as an order, if that price changes to $3, all of a sudden, you’re going to pay $3 for that. I always enter my orders as limits. I want to see if I can get it at that particular price. If I can’t, I can always change my order, but I don’t want to pay more than $1.98.
That limits me to the amount that I actually pay when I submit that order. You can submit this order for the day, you can submit it “good until canceled.” In other words, if you submit an order to purchase this June 72 call, one of these, at $1.98, and you select “day,” that means that they will try to get you that price the entire day, until the market closes.
If the market doesn’t give you that price, then the order automatically expires at the end of that trading day. You won’t have that order the next day. It will cancel. It will be over. They will terminate the order. If you want to continue to purchase that option the very next day, you’d have to put the order in again.
You can also submit your order as “GTC,” or “good till canceled.” This means that this order will stay on the brokerage firms’ computers, and will be executed at any time today, tomorrow, a week from now, or even two weeks from now, until this option expires, for $1.98.
Generally, I don’t like to do those kinds of orders, because they’re just too long for me. Normally, I do day orders. But you also have the option of doing an extended hours order. Normally, those are only during extended hours. I normally go with day, and the reason is, normally, if I put in an order for this particular option – and within five minutes, I don’t get filled with the price I want, I cancel the order. I don’t like to hold that order for more than a few minutes.
The reason is that the market can change dramatically. Maybe I can get it at a lower price. Normally, if you’re just buying or selling a single order, the reason that there’s an asking price here of $1.98, is that the market makers have quoted this as a price at which they will sell this option for $1.98.
If they were not willing to sell it for $1.98, they would not have a quote of $1.98 here. On a single option order, you can submit this. As long as the price does not move dramatically, they will fill the order instantly, at $1.98.
On some options, you can actually ask for a mid-price order. This is during the weekend, after the markets are closed, and the bid and ask are a little bit farther apart than they normally are, on the IWM. Usually, they’re a penny or two cents apart, so normally, you’re going to buy at the asking price, and you’re going to sell at the bid price. There’s nothing in the middle of that. There’s no mid-price on single options.
If they did have a wide enough spread, you could go down, maybe a penny. You can see what I did here. The platform of TOS always shows what the natural price is, and what the mid-price is. You could try to split the price and get it down to $1.97 or $1.96, which is the middle price between the $1.94 bid, and the $1.98 ask.