I am trying to get a grasp on how the bid-ask match maker works, in particular for options as there is less volume and fewer market orders. Lets say I own an option, and place a limit sell order for $10.00 overnight. Now, overnight something happens which causes the stock to pop, and for whatever reason other traders don't see my sell order for $10.00 and place bids at $20.00 pre-market open. Now at market open for an instant there is a bid-ask spread of $20 - $10. My question is, which takes priority? Is it based on the time the order was placed, even when the market is closed?
When you place a limit sell order of $10.00 (for a stock on an option) you are adding your order to the book.
- For example, here is the order book for AAPL http://finance.yahoo.com/q/ecn?s=AAPL+Order+Book
Anyone who places a buy at-the-market or with a limit price over $10.00 will have that order immediately fulfilled through the offer you have placed on the book.
On the other hand, if that other person places a buy for $8.00, then the spread will now be "$8.00 bid, $10.00 ask".
Priority is based on first the price (all $9.99 asks will clear before $10.00) and within each bucket this is based on the time your order was submitted.
This is why in bidding markets (including eBay) buying at $x.01 is way better than $x.00 and selling at $x.99 is better than $(x+1).00.
Source: https://en.wikipedia.org/wiki/Order_(exchange) under "first-come-first-served"
The options market requires much more attention to avoid the situation you're describing.
An overnight $10 ask will remain on the books most likely as Good-Til-Canceled. The first to bid the low order gets it. If traders are paying attention, which they probably are then they will bid at $10. If not, they will bid immediately at $20.
If they crossed the order, it would be filled at their higher than $10 bid.
This is all governed by the exchange where the ask is posted, and most implement price-time priority.