It’s been a while since I’ve done a mailbag essay.
But, please know my team and I enjoy receiving your comments and questions and read every single one. With that, I’d like to take some time out from the markets to answer a few questions that have been popping up quite a bit lately.
So, let’s see what’s in the mailbag…
I started with Jeff Clark Trader, and have learned more about the market by studying your videos than I ever had before [click here to watch the first three videos in Jeff’s training lessons, for free]. Thank you for being an excellent teacher. I’m considering upgrading to your next level.
One thing that’s very confusing to me is the difference between the bid and the ask price for the option. There are major differences in most cases. How does one go about purchasing the option, making an offer (if so, how much?), accepting the ask price, and/or offering at the bid price?
It looks like a big part of option profits must be in buying the right price between bid and ask. With stock, I usually buy at the closing price the next morning. But with options, often, there’s no closing price. Regards.
– Blue
Hi Blue, just like when you’re buying and selling stocks, when you buy an option you pay the “ask” price. And, when you sell an option, you sell it on the “bid” price. As you point out, though, sometimes there’s a fairly widespread difference between the bid and ask. In those cases, it’s often possible to split the bid and ask prices, and trade in between.
For example, if an option bid is $1.00 and is offered at $1.10, then it’s reasonable to enter an order to trade at $1.05. Sometimes you’ll get it. Sometimes you won’t. But, there’s no harm in trying. If the trade isn’t executed within a few minutes, then you can always cancel the order and re-enter it at the bid or ask price.
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Jeff’s essay on option market orders is certainly valid! My experience agrees that limit orders are the only safe plan of action for trading options. On the other hand, I routinely see futures day trades placed with market orders, sometimes with slippage in fast moves – but there seems to be less concern that traders are getting ripped off by colluding market makers.
Is this not a concern in futures too, or is there something else going on there? Perhaps as a function of the speed and liquidity of the futures markets versus the options markets?
– Darryle
Hi Darryl, your suspicions are correct. The speed and liquidity in the futures markets allows traders to enter market orders with less risk of poor price executions. In the option market, the relative limited liquidity can result in poor price executions on market orders.
Would Jeff kindly add suggestions for Level 0-2 traders? Since I’m only a Level 1 trader so far, I can’t sell uncovered puts as Jeff suggests. So, what would Jeff suggest a Level 0-2 trader, such as me, do? I don’t want to apply for higher levels until I’m comfortable with my current level. Thank you!
– Michael
Hi Michael, Level 1 allows you to buy call and put options. Level 2 allows you to sell uncovered put options. In order to qualify for Level 2, most firms require some degree of experience with trading options and a minimum of $10,000 equity in your account.
Selling uncovered puts and buying speculative call options are both bullish strategies – meaning they’re designed to profit on a rally in the underlying stock. So, I could simply tell you that if you can’t sell uncovered put options, then just go ahead and buy speculative calls instead. But, there is often a big difference in the “probability” of a profit between those two strategies.
For example, in the case of the trade you referenced, I recommended selling uncovered puts rather than buying calls because it looked close enough to a bottom that an uncovered put option trade would likely make money. But, it wasn’t close enough to a rally that we’d be able to profit on a speculative call option purchase.
By selling uncovered puts, we received the premium up front. And, we’ll make money if it rallies, stays the same, and even if it falls a bit more.
The only way we can profit on a speculative call option purchase is if the trade rallies.
So, the probability of profiting on an uncovered put option trade is much higher than on a call option trade. And again, since my view was that the trade was close to a bottom but maybe not quite ready to rally, selling uncovered puts made sense. But, it was too early to buy speculative calls.
If you’re not able, or willing, to sell uncovered puts, then just pass on those trades. We’ll have plenty of other trades with speculative puts and calls.
Best regards and good trading,
Jeff Clark
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