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Question By Ifiok
"Who Is Bidding & Who Is Asking?"
Please, in the ask and bid prices, who is asking and who is biding? What effect has this to the strike price or the current price of the underlying asset and yet more to option price.?
Asked on 12 July 2010
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Answered by Mr. OppiE
Hi Ifiok,
All financial instruments traded in the capital markets, whether shares, bonds or other derivatives, go through an open auction process where buyers and sellers openly compete for prices. This is not something unique to options trading. Buyers will be bidding for your options and sellers will be asking for a certain price for their options. This is why you get an immediate fill if you buy on the ask price and sell on the bid price. The difference between the ask price and the bid price is known as the "Bid Ask Spread".
For instance, you wish to buy an options contract and at the same time there is a seller of that options contract in the options market asking for $2.00 per contract (reflected in the ask price in the options chain). If you think $2.00 is a fair price to pay for that options contract, you could put in an order on that ask price and get an immediate fill. Otherwise, you could wait for the ask price to change to one which suits you or put in a price that you wish to pay. Once you do that, you become a bidder to buy in the options market and your price will appear in the bid price if your bid price is higher than the prevailing bid price. For instance if the bid price for that contract is now $1.50 and you think $1.80 is a fair price to pay, you could put in an order to buy at $1.80 and since it is higher than the prevailing bid price of $1.50, your bid of $1.80 will become the current bid price. Now, if another options trader is trying to sell the same number of those options contracts, he will now sell it to you at your bid of $1.80. However, the risk in doing so is that in a fast moving market, both the bid and ask prices may be moving up so quickly that your bid price will become lower than the new bid price very quickly and then you will perhaps end up missing the whole trade.
In reality, bid and ask prices are both created by market makers in the options market. Market makers compete for prices and then buy from and sell to options traders like you and me. In order to make a profit, market makers will always be looking to buying slightly lower and selling slightly higher. This also results in the bid ask spread.
So, does bid and ask price affect the strike price of an option? Of course not. Strike prices are fixed and do not change.
Does bid and ask price affect the price of the underlying stock? Of course not. The price of the underlying stock can only be temporarily affected by the strike price of an option if a huge contract gets exercised.
Does bid and ask price affect the price of the option? Of course it does. Bidding and asking is the process through which the price of an option change and the mechanism through which options get trade.
In conclusion, bid and ask price is the mechanism through which all financial instruments are traded and the process through which the best price for an asset under the prevailing market conditions can be reached. In the options market, market makers compete against other market makers and creates the bid and ask price in order to buy from and sell options to options traders at large. Learn all about Options Prices.
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