Invest and Trade Profitably with Jon Johnson

Do you have any specific advice for negotiating the huge spreads these mm’s are placing on option strike prices? I’m only trading 4-5 calls at a time and I’m reluctant to pay the whole spread on some of these plays. However, I’m not getting filled half the time. Is there any specific technique you use?

August 30, 2000

With respect to large option spreads we note in the nightly report and in the alert if it is a spread that is too wide to realistically make money on. That is usually because of poor liquidity and thus the market maker plays with the spread to insure his book. When that happens we typically forego the option play and look to the stock. That means an option trader will let that one go by; nothing wrong with that if it does not fit your criteria. If there is a wide spread that we still want to try, however, then we will offer what we think is a decent price for the option to buy it, using theoretical values as a guide along with the spread and the price of the underlying stock. If a spread gets over 70 cents it starts getting too hard to get the kind of return you need. That said, on BIDU, NTES, GOOG and other higher priced stocks, a spread of $2 to $3 is normal and as these stocks make $25 moves it is, proportionally, no issue. Sometimes we try to break the spread and it works, other times the market maker just laughs at us. If we can’t get it, then we don’t want it and we move on to something with more liquidity.

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