Purchasing options between the bid and ask prices, or even at the bid price or below?

Question

For those more experienced options traders, I'm wondering if you can share what you've found in regard to purchasing near, at or possibly below the bid. For example, yesterday in a slightly rising market for a stock, I placed a limit order to buy a call at the bid price, and it was executed after about 5 minutes, even as the stock was rising in price slightly, but steadily. My specific questions are:

1) How often are you able to buy an option either close to, at, or below the bid price. Are there things particular to market conditions that allow this? (Obviously in a falling market, the bid price is also falling .. i.e. hence hopefully the question is still valid)

2) Same question on the sell, in regard to the ask

3) Do you notice better ability to do this for puts rather than calls?

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[if you look at the black-sholes formula price] 4) Do you notice better ability to do this as a factor of what the black-sholes formula says the real option price should be. I.e. if it shows quite a bit lower value than the bid price, does this influence what you see occurring?

Thanks much. I'm imagining all experienced options traders run in this either directly or indirectly, as limit orders are hit? Your experience is much appreciated.

---- I want to add this graph that really helps show things and the response to this question and still wanting more answers. The stock / option doesn't matter. So this graph is from this morning, look at the option prices, volume, stock price, and volume.

Answer 1

I understand the question, I think. The tough thing is that trades over the next brief time are random, or appear so. So, just as when a stock is $10.00 bid / $10.05 ask, if you place an order below the ask, a tick down in price may get you a fill, or if the next trades are flat to higher, you might see the close at $10.50, and no fill as it never went down to your limit.

This process is no different for options than for stocks.

When I want to trade options, I make sure the strike has decent volume, and enter a market order.

Edit - I reworded a bit to clarify. The Black–Scholes is a model, not a rigid equation. Say I discover an option that's underpriced, but it trades under right until it expires. It's not like there's a reversion to the mean that will occur. There are some very sophisticated traders who use these tools to trade in some very high volumes, for them, it may produce results. For the small trader you need to know why you want to buy a stock or its option and not worry about the last $0.25 of its price.

Answer 2

Yes, almost always.

I trade some of the most illiquid single stock options, and I would be absolutely murdered if I didn't try to work orders between the bid/ask. When I say illiquid, I mean almost non-existent: ~50 monthly contracts on ALL contracts for a given underlying. Spreads of 30% or more.

The only time you shouldn't try to work an order, in my opinion, is when you think you need to trade immediately (rare), if implied volatility (IV) has moved to such a degree that the market makers (MM) won't hit your order while they're offering fair IV (they'll sometimes come down to meet you at their "real" price to get the exchange's liquidity rebate), or if the bid/ask spread is a penny.

For illiquid single stock options, you need to be extremely mindful of implied and statistical volatility. You can't just try to always put your order in the middle. The MMs will play with the middle to get you to buy at higher IVs and sell at lower.

The only way you can hope that an order working below the bid / above the ask will get filled is if a big player overwhelms the MMs' (who are lined up on the bid and ask) current orders and hits yours with one large order. I've never seen this happen.

The only other way is like you said: if the market moves against you, the orders in front of yours disappear, and someone hits your order, but I think that defeats the intent of your question.

Answer 3

People must simply be willing to match your orders if they know about it. You can sniff orders out if you can see them or predict them. For instance, you can look at an order book and decide who you want to get filled at, especially if you are looking at different quotes from different exchanges. So you can get a "better" fill just by looking at what someone is willing to pay to enter/exit their order as well as what exchange they placed their order through, and send an order to that specific exchange to match them. You (or a program) can just watch the level 2's and place an order as soon as you see one you like. The orders on the level2's do not reveal ALL interested market participants.

Also many brokers have difficulty updating options quotes.

Finally, options & market volatility can inflate or decrease the price of options by large percentages very quickly.

Answer 4

I frequently do this on NADEX, selling out-of-the-money binary calls. NADEX is highly illiquid, and the bid/ask is almost always from the market maker. Out-of-the-money binary calls lose value quickly (NADEX daily options exist for only ~21 hours). If I place an above-ask order, it either gets filled quickly (within a few minutes) due to a spike in the underlying, or not at all. I compensate by changing my price hourly.

As Joe notes, one of Black-Scholes inputs is volatility, but price determines (implied) volatility, so this is circular. In other words, you can treat the bid/ask prices as bid/ask volatilities. This isn't as far-fetched as it seems: http://www.cmegroup.com/trading/fx/volatility-quoting-fx-options.html

Answer 5

This sometimes happens to me. It depends on how liquid the option is. Normally what I see happening is that the order book mutates itself around my order. I interpret this to mean that the order book is primarily market makers. They see a retail investor (me) come in and, since they don't have any interest in this illiquid option, they back off. Some other retail investor (or whatever) steps in with a market order, and we get matched up. I get a fill because I become the market maker for a brief while.

On highly liquid options, buy limits at the bid tend to get swallowed because the market makers are working the spread.

With very small orders (a contract or two) on very liquid options, I've had luck getting quick fills in the middle of the spread, which I attribute to MM's rebalancing their holdings on the cheap, although sometimes I like to think there's some other anal-retentive like me out there that hates to see such a lopsided book. :)

I haven't noticed any particular tendency for this to happen more with puts or calls, or with buy vs sell transactions. For a while I had a suspicion that this was happening with strikes where IV didn't match IV of other strikes, but I never cared enough to chase it down as it was a minor part of my overall P/L.