Who is on the other side?
Understanding the Bid-Ask spread, liquidity, and the role of Market Makers.
The Bid-Ask Spread
The price of an option isn't a single number. It's a negotiation. Just like a house or a used car, there is a price buyers want to pay and a price sellers want to receive.
Pro Tip: Always use Limit Orders
Never use "Market Orders" on options. You will get filled at the worst possible price (the Ask for buyers, the Bid for sellers).
Market Makers
You rarely trade with "Bob from Ohio." You trade with institutions obligated to always provide a buy and sell price.
They take on risk to hold these positions. The "Use Spread" ($0.10 in our example) is their fee for this service.
They don't care if the stock goes up or down. They hedge their directional risk instantly with shares.
How to Spot "Good" Liquidity
Volume (The Traffic)
The number of contracts traded today. Resets to zero every morning. High volume means it's easy to get in and out.
Open Interest (The Crowd)
The total number of contracts that exist and are open. Does not reset. Represents total active bets in the market.
Warning: The Wide Spread Trap
If Volume and Open Interest are low, the spread will be "wide" (e.g., Bid $1.00 / Ask $5.00). Do not trade these illiquid options. You will lose money immediately upon entry due to slippage.