Use the Bid-Ask Spread to Never Overpay for a Stock Again

I walked away from the perfect home, and it was the right choice.

My wife and I had been shopping for about a year when we got the showing we’d been waiting for.

It was on a quiet street, had four bedrooms, a pool and impact windows (something that is a must living in Florida).

But we passed on buying it…

After doing our research into its value, we realized the seller was way off … tens of thousands of dollars off.

Sellers usually negotiate some, but when we put in a fair offer, this one flat out rejected it.

At the end of the day, me and the seller didn’t see eye to eye on the value of the home. And I wasn’t willing to compromise.

In finance, we call this a “mispricing.” This is how we find a lot of our trades in Weekly Options Corner (and in our sister newsletter, American Investor Today). But this mispricing was in the wrong direction.

Now, normally, we want to buy things when the seller is valuing them very cheaply. But when a seller thinks something is worth way more than it is … then we have to have the confidence to walk away.

Mispricings — both good and bad — happen every day in the options market.

Using the “Bid-Ask” Spread

Many options are listed too high, and if you don’t do the research, you’ll quickly be sucked into overpaying for the trade you want to make.

Here’s how to avoid those pitfalls…

Options use similar language to real estate. The prices we’re talking about are called the “bid” and the “ask.”

The bid is the price a buyer is willing to pay for the option right now. The ask is the price the seller is willing to take for that option right now.

So the buyer places a bid, and the seller decides whether they want to take it. The seller also lets the buyer know the price they’re willing to sell the option for.

When you go to place an order for an option, your broker will show you the recent bid and ask prices — essentially showing you what the market is valuing these options at.

They call the difference between the bid and ask prices the “bid-ask spread.” And in general, what options traders want is a tighter bid-ask spread.  Think about it: You’re more likely to have your bid on a house accepted when it’s closer to the seller’s asking price. Ideally, you want that difference to be very small.

If the spread is too wide, it can cause nightmares for your portfolio. It’s a sign the market is out of whack on the option. If you aren’t careful, you can end up paying far too much (or selling for far too little). We recommend you don’t go after options with large bid-ask spread unless you really know what you’re doing.

These stocks are going to have the most heavily traded options — the ones with a very tight bid-ask spread — indicating that there are plenty of buyers and sellers for those option contracts.

Here’s what I mean…

Focusing on the Spread

When I first started to do the research into my No. 1 options service, Quick Hit Profits, I knew I wanted to recommend options on stocks with these “liquid” options — those are options that have a lot of people trading them.

I knew many cheap stocks and penny stocks were not going to have many easy-to-trade options.

Right out of the gate, I limited my scope to stocks with the most liquid shares in the world — the S&P 500. That’s 500 of the largest stocks in the U.S.

Liquid shares translate into liquidity for options, too. That means we don’t have to pass on a potential profit opportunity just because the options have wide spreads.

Close bid-ask spreads guarantee easy trades and exits.

That’s the key.

By using my Profit Trigger and only looking at these specific stocks, I’m setting myself up to win. If you have a profitable strategy to follow, all you have to do is place the trades it generates to get some of the best profit opportunities.

The truth is, we walked away from what we thought was the perfect house that day. But about a year later, we stumbled upon a true “forever home,” as my wife calls it — one that was bigger and even more beautiful than the one we walked away from.

Some opportunities are meant to be passed up.

Use the bid and the ask to help you identify the ones to avoid.

That’s all for today.

I plan on walking you through a live trade in the coming weeks. We have been busy this earnings season with new trades, and I want you to see what the action is all about.

I’ve also spoken with my publisher, and he’s let me create a special offer just for Weekly Option Corner readers.

I’m excited to share that with you soon as well.

In the meantime, keep your questions coming in. You can send them to our team at WeeklyOptionsCorner@BanyanHill.com.

Regards,

Chad Shoop, CMT

Editor, Automatic Profits Alert

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