DATE: January 28, 2012
Can you please discuss how the bid-ask spread for options is determined?
The Cboe does place limits on the maximum width that an option market can have. For most electronic quotes, excluding those during opening rotation, the maximum width is $5 dollars. So, for example, an option that shows a $3 dollar bid may not show an ask price greater than $8 dollars. Of course, with so many market participants competing with each other, it is rare to see a market where the bid-ask spread is $5 dollars wide. Open competition among market participants means that real market widths are typically far narrower than the allowable maximum.
There are other limits that you can find on CBOE's website if you search for market widths. However, once again, due to the multitude of market participants on CBOE, it is rare to see quotes displaying their legal maximum widths. To learn more about how the bid-ask spread for options are determined, view this week's segment of "Ask the Institute."