CHAPTER 8

The Bid/Ask Spread

The bid/ask spread is how market makers make their money, and some of them have made a ton of it.

Everyone who’s traded stock or options knows that the last traded price is just the beginning. When it’s actually time to execute a trade you’re faced with two prices, the bid price and the ask price (sometimes called the offer or offer price). The bid price is the price that the market is bidding for your stock or option. It is the price the market is willing to pay you for your stock or for options if you want to sell. If you wanted to sell a single share or option immediately, then you’d expect to receive the bid price.

The ask price is the price that the market is asking for in order to sell you stock or options. It is the price the market is willing to accept in exchange for selling your stock or option to you. If you wanted to buy a single share or option immediately, then the ask price is the price you’d expect to pay. Think of the bid price as the wholesale price, think of the ask price as the retail price.

WHAT DO WE MEAN BY “THE MARKET”?

When we refer to “the market” we really mean the combination of all the market participants. There might be market makers, high-frequency traders, hedge funds, and long-term investors who are willing to pay the bid price. The bid you see on your screen is generated by all those who have entered limit orders saying that they’re willing to pay that bid price (but no more) in order to buy this stock or option. You ...

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