Simple Option Strategies

The Gap Between the Bid and the Ask

Rosa had done everything right. She'd picked her strike, checked the distance from the market, and decided the trade was worth taking. The screen showed the option she wanted to sell at $1.20.

She clicked "sell," chose "market order" because it was the default, and confirmed.

The order filled instantly — at $1.00.

Rosa stared at it. Twenty cents per share might not sound like much, but options cover 100 shares each, and she'd sold 5 contracts. That was $100 gone in one click, on a trade where she was hoping to make $600. She hadn't even placed a bad trade. She'd just placed a good trade badly.

Every option has two prices

What Rosa saw as "$1.20" wasn't actually a price anyone was offering. It was the midpoint — halfway between two real prices that every option has at every moment:

• The bid: the highest price someone is currently willing to pay. If you want to sell right now, this is what you'll get.

• The ask: the lowest price someone is currently willing to sell for. If you want to buy right now, this is what you'll pay.

The gap between them is called the bid-ask spread. On Rosa's option, the bid was $1.00 and the ask was $1.40. A market order says "fill me right now at whatever price is available" — and for a sale, the price that's available is the bid. So she got $1.00.

The person on the other side of her trade, often a market maker whose job is to stand in the middle, effectively collected that gap.

Why the gap exists

Market makers aren't villains. They're the reason you can trade at all. They're willing to buy when you want to sell and sell when you want to buy, at almost any moment of the trading day. The bid-ask spread is how they get paid for taking that risk and providing that convenience.

How wide the gap is depends mostly on how actively something trades. Very popular options, with lots of buyers and sellers, tend to have tight spreads — sometimes just a nickel or a dime. Rarely traded options can have huge ones. The gap also tends to widen when markets are moving fast, right at the open, and near big news events, because that's when market makers are taking the most risk.

How the gap adds up

One trade, $100. It's annoying but survivable. The problem is that the gap is there on every trade, both when you open and when you close. If Rosa traded like that twice a week for a year, she'd be handing over something like $10,000 just in the space between bid and ask — on top of any actual losses.

With spreads, this matters even more. A credit spread has two options, so it has two bid-ask gaps. Trade a four-leg position and you've got four. The costs stack.

How to keep more of the gap

The fix is surprisingly simple:

1. Use limit orders. A limit order says "fill me at this price or better." Rosa could have offered to sell at $1.20, the midpoint. Often, especially in liquid products, an order near the middle gets filled within a few seconds to a few minutes.

2. Be willing to walk the price. If the midpoint doesn't fill, nudge your limit a penny or two at a time toward the bid. You'll usually end up somewhere better than a market order would have gotten you.

3. Trade liquid products. Some underlyings have far more trading activity than others, which keeps spreads tighter. This is one reason we trade SPX options — they're among the most actively traded options in the world.

4. Be careful at the open. The first few minutes of the day often have the widest spreads. A little patience frequently gets a noticeably better price.

The bigger lesson

There's a pattern here that shows up all over trading: the costs that hurt most are the ones you don't see. Nobody shows the bid-ask spread on a profit chart. It doesn't feel like a loss. It just quietly makes every win a little smaller and every loss a little bigger.

The traders who last tend to sweat these small details — not because any single one is a big deal, but because they show up on every trade, forever.

What Rosa changed

She went into her platform settings and switched the default order type from "market" to "limit." It was a 20-second fix. She figured it was worth about $100 a trade.

The takeaway: the price on the screen isn't the price you'll get unless you ask for it. Use limit orders, and know both sides of the market before you click.

Simple Beats Clever

Ethan was an engineer, and he traded like one.

His trading screen had four monitors. One showed price charts with seven different indicators layered on top: moving averages, momentum oscillators, volume bands, a custom line he'd coded himself that combined three of the others. Another monitor showed his options positions, which usually involved five or six different legs at different strikes and expirations, carefully balanced so that the overall position made money in a very specific set of scenarios.

It was beautiful. He'd spent months building it. And at the end of the year, it had made him about $40.

The experiment

What made Ethan's year interesting is that he'd accidentally run an experiment. His wife had asked him, back in January, to set up a small account for her too. She didn't want anything complicated. So Ethan gave her the simplest thing he could think of: one credit spread on SPX at a time, a set distance from the market, a set size, with a written rule for when to take profits and when to step in and manage it. No indicators. No custom lines. He spent about ten minutes a week on it.

By December, her simple account was up $880. His clever one was up $40.

Ethan did what engineers do. He went looking for the bug.

What he found

It took him a few evenings, but he found it. There wasn't one bug. There were dozens.

Every one of his indicators gave a signal now and then that conflicted with the others, and he had to decide which one to trust. Usually he trusted the one that agreed with what he already thought. His multi-leg positions had so many moving parts that when the market did something unexpected, he couldn't tell right away whether he was winning or losing, let alone what to do about it. Every complex position also meant more contracts, more fills, more slippage, and more fees — small costs that piled up quietly all year.

Worst of all, the complexity made every decision a judgment call. Some months his judgment was great. Some months it wasn't. You can see it in the orange line on the chart: big up months, big down months, and almost nothing to show for it in the end.

His wife's account had none of that. There was only one decision, and the rule already made it.

Why simple works better than it should

Complexity feels like an edge. If a strategy is hard to understand, it seems like it must be sophisticated, and sophisticated seems like it must be better. But in trading, complexity tends to add three things, and none of them help:

1. More ways to be wrong. Every extra indicator or leg is another assumption that has to hold up. The more assumptions, the more likely one of them breaks.

2. More room for your own bias. When the rules are fuzzy, you fill the gaps with feelings — and feelings are at their worst when money is moving.

3. More friction. More legs means more commissions and wider combined bid-ask costs, every single time.

A simple strategy, on the other hand, is something you can actually follow, especially on a bad day. And a strategy you follow consistently will beat a brilliant one you only follow when you feel like it.

What "simple" doesn't mean

Simple isn't the same as careless. Ethan's wife's account had clear rules about size, about distance from the market, about when to take profits and when to adjust. The thinking was done up front. It just didn't need to be redone every day.

That's how we try to approach our own trading. We don't use a wall of indicators, and we don't build trades that need a diagram to explain. We sell defined-risk credit spreads, we know the maximum loss before we enter, and the rules for managing them are written down in plain language. The goal is a process someone could explain to a friend in a few minutes — and follow on their worst day.

What Ethan did

He didn't quit coding. He just pointed it at something different. Instead of building more indicators, he wrote a little program that checked his wife's simple account every morning and told him whether any of the rules needed attention. Most days, it said nothing.

Then he moved his own money into the same strategy and turned off three of the four monitors.

The takeaway: a strategy only works if you can follow it. The simpler the rules, the more likely you'll follow them when it counts.

The Money Is Already Gone

Priya had a rule for her car. If a repair cost more than the car was worth, she'd stop fixing it. It was a good rule. She never followed it.

Her old sedan had needed a transmission, then brakes, then a new radiator, and every time she'd said the same thing: "I've already put so much into it." By the time it finally died in a parking lot, she'd spent more on it in two years than it would have cost to buy something reliable.

She didn't realize she was about to do the exact same thing with a trade.

The trade

On Monday, Priya sold a call spread on SPX for $2.50 per contract. The spread was 25 points wide, so the most she could lose, if the market ran straight through both strikes, was $2,250 per contract. The most she could make was the $250 she collected up front.

By Thursday, the market had rallied hard. The spread that she sold for $2.50 now cost $8.50 to buy back. If she closed it, she'd lock in a $600 loss.

Six hundred dollars. Priya looked at that number for a long time. "I can't close it now," she told herself. "I'd be throwing away $600."

The question she was really answering

Here's the thing about that $600: it was already gone.

Whether Priya closed the trade or held it, she was down $600 on Thursday morning. That wasn't a decision anymore. It was a fact. The only decision in front of her was about what happened next — and the $600 had nothing to say about that.

Economists call this the sunk cost fallacy. Money, time, or effort that's already spent and can't be recovered is "sunk." The fallacy is letting sunk costs drive future choices. It's why people finish movies they hate because they paid for the ticket, and why Priya kept fixing a car that had stopped making sense.

Look at the chart above. Priya's real choices on Thursday were these:

• Close now: take a $600 loss and move on.

• Hold, and the market comes back: best case, the spread expires worthless and she keeps the full $250.

• Hold, and the market keeps going: worst case, she loses $2,250.

The right answer depended on where the market was, how much time was left, and what her plan said. It did not depend on the $600. That number sits underneath every one of the choices equally. It can't make one of them better than another.

Why it feels so different from the inside

If sunk costs are so obviously irrelevant, why does almost everyone fall for them?

Partly because closing a losing trade turns a paper loss into a real one, and that feels like admitting a mistake. As long as the trade is open, there's hope. Closing it ends the story with us on the losing side.

And partly because our brains keep score in a strange way. Losing $600 by choosing to close feels much worse than losing $600 by letting the market do it. One feels like our fault. The other feels like bad luck. So we hold on, and we let the market make the decision for us — often at a worse price.

The fresh-eyes test

There's a simple question that cuts through all of it:

If I had no position right now, would I open this exact trade, at this price, today?

On Thursday, the answer for Priya was clearly no. Nobody looking at that chart fresh would sell a call spread with the market charging right into it. Which meant the only reason she was still holding was the $600 — and the $600 was the one thing that couldn't be changed.

How we think about it

This is one reason we decide our exits before we enter. When the plan for a losing trade is written down ahead of time — an exit level, or a rule to adjust the position at a certain distance — there's no Thursday-morning debate. Nobody has to stare at a red number and decide how they feel about it. The plan already made the call, back when the money wasn't on the line.

Losses that are handled by the plan stay small. Losses that are handled by hope have a way of growing.

What Priya did

She closed the trade. It stung. Over the next week, the market kept climbing, and the spread would have hit its maximum loss.

That evening she thought about the old sedan, and wrote a new rule on the inside cover of her trading notebook: Ask what to do next. Not what it cost to get here.

The takeaway: money you've already lost can't vote on your next decision. Decide what to do from here, as if you'd just walked in.

Yesterday Isn't a Forecast

Marcus kept a notebook. He'd started it to get more disciplined, and in a way it worked — it just taught him the opposite lesson from the one he expected.

It was early spring, and the market had gone up three days in a row. Not big moves, but steady ones. Marcus was sure he saw a pattern. "When it gets going like this," he told a friend, "it keeps going." On the fourth morning, he skipped his usual plan and placed a bigger, more one-sided trade, betting the run would continue.

The market dropped 40 points before lunch.

That night, annoyed, he flipped back through his notebook. He'd been writing down market moves for almost a year. And on a whim, he did something he'd never done before: he went through and found every time the market had gone up three days in a row, then looked at what happened on the fourth.

There were 20 of them. Eleven times the market went up the next day. Nine times it went down.

Marcus stared at it. Eleven and nine. That wasn't a pattern. That was a coin flip with a little extra weight on it — the kind of slight upward tilt the market has over most stretches of time anyway. Three up days hadn't told him anything about the fourth.

Why the brain loves recent history

Our brains are pattern-finding machines. That's a gift most of the time. It's how we learn which foods make us sick and which roads have traffic at 5 p.m. But markets are noisy, and a pattern-finding machine pointed at noise will find patterns that aren't there.

The most powerful of these is what researchers call recency bias — giving too much weight to what just happened. A few strong days and the market feels unstoppable. A few weak days and it feels like it's breaking. The last thing we saw becomes the thing we expect to see next.

But the market doesn't remember yesterday the way we do. Thousands of buyers and sellers show up every morning with new information, new orders, new reasons. Yesterday's move is already in the price. It doesn't push today in any particular direction.

The two ways it costs you

Recency bias tends to hurt in two ways.

First, it makes you change your plan based on a few days of evidence. Marcus didn't just have an opinion — he acted on it, with a bigger and more lopsided trade than his rules allowed. A plan built on months of thinking got thrown out because of 72 hours.

Second, it makes you too confident at exactly the wrong time. After a run of calm, up days, it feels safe to sell options closer to the market or trade a little bigger. After a sharp drop, it feels dangerous to trade at all. Both feelings come from the last few days, and neither one is a measurement of actual risk.

What to look at instead

The way out isn't to ignore what the market did. It's to look at the right things and at the right time scale.

• Volatility, not direction. A string of up days tells you little about tomorrow's direction. But how much the market has been moving — how big the daily swings have been — does tell you something useful about how much room a trade needs.

• Your rules, not your read. If your plan says sell a spread a certain distance away, at a certain credit, that plan already accounts for the market going either way. That's the point of it.

• A big sample, not a small one. Marcus's notebook only became useful when he looked at 20 cases instead of one. If you think you see a pattern, write it down and test it before you trade it.

How this fits the way we trade

A big reason we sell credit spreads instead of betting on direction is that we don't think anyone — us included — can reliably call the next day's move. We set up trades that can win if the market goes up a little, sideways, or even down a little. We don't need yesterday to repeat itself, and we don't need to guess whether it will.

That's freeing, actually. You don't have to have an opinion about whether three up days means a fourth.

What Marcus changed

He kept the notebook, but he added a page at the front titled "Patterns I Thought I Saw." Every time he felt sure about what the market would do next, he wrote it down instead of trading it. A month later he'd go back and check.

The page filled up fast. The hit rate hovered around half.

The takeaway: yesterday is already in today's price. Trade your plan, not your memory of the last three days.

Seeing What You Want to See

Lisa had a ritual. Every morning before work, she poured a coffee, opened her trading account, and then opened the news.

She had sold a put spread on SPX a week earlier, with her short strike 150 points below the market. It was a good trade when she placed it. Plenty of room, a fair credit, a clear plan. The plan even had a rule written on a sticky note on her monitor: If SPX gets within 100 points of the short strike, act.

Then the market started to slip.

The first day it fell 12 points, Lisa found an article titled "Why This Dip Is a Buying Opportunity." She read every word. The next day it fell another 17, and she found a strategist on TV saying the economy was stronger than people thought. She watched the whole clip twice.

There were other headlines too. A story about slowing earnings. A chart showing the market had broken below a level it had held all month. Lisa saw them. She just didn't click on them. They felt like noise. The bullish stories felt like information.

By the following Tuesday, SPX was 84 points above her short strike. The sticky note said act at 100. Lisa read three more articles that morning about why the selling was almost over, and did nothing.

What was happening in Lisa's head

Lisa wasn't foolish. She was doing what every human brain does once it has made a commitment: looking for proof that the commitment was right.

Psychologists call this confirmation bias. Once we hold a position — in the market, in an argument, in an opinion about a restaurant — we notice the evidence that supports it and quietly brush off the evidence that doesn't. A headline that agrees with us feels important. One that disagrees feels like somebody who doesn't understand the situation.

Here's the thing Lisa missed: none of those articles changed the odds of her trade. Not the bullish ones, not the bearish ones. The only fact that mattered was sitting right there on her screen. SPX was getting closer to her strike every day, and her own rule had already told her what to do about it.

The news made her feel better. It didn't make her safer.

Why it's so hard to catch

Confirmation bias doesn't feel like bias. It feels like research. Lisa wasn't ignoring her position — she was reading about the market every single morning. She would have told you she was being diligent.

That's what makes it dangerous. The more you read, the more material your brain has to cherry-pick from. Someone, somewhere, is always making the case for exactly what you want to happen. If you go looking for that person, you'll find them every time.

What a rule does that a feeling can't

The sticky note on Lisa's monitor was the most valuable thing on her desk. She wrote it on a calm day, before the trade was on, when she had no reason to fool herself. That's exactly when good rules get made.

A rule doesn't read the news. It doesn't care how persuasive the strategist on TV was. It looks at one thing — how far the market is from the strike — and gives you an answer.

This is why we manage our longer-dated positions by distance, not by opinion. When the market gets within a set number of points of a short strike, the position gets adjusted. We don't wait for a headline to tell us it's okay. We don't wait for the market to "prove" itself. The distance is the signal.

How to catch yourself

A few habits help:

1. Write the rule before the trade. Your judgment is best before you have money on the line. Use that version of you to make decisions for the later version.

2. Read the other side on purpose. If you're short puts, go find the most convincing bearish argument you can. If it doesn't change anything, fine. But you should know what it says.

3. Ask the honest question. "If I didn't have this trade on, would I open it right now, here?" If the answer is no, you're holding it for reasons that aren't about the market.

What happened to Lisa

Two days later, SPX dropped another 30 points in a morning. Lisa finally adjusted — at a worse price, with less time, and a lot more stress than if she'd followed the note the week before. The trade ended up as a modest loss. It could have been a small one.

She kept the sticky note. She added a second line underneath: The news doesn't get a vote.

The takeaway: once you're in a trade, your brain becomes its lawyer. Set your rules before you're in, and let them be the judge.

When a trade moves against you, adding more at a "better price" can feel smart. Usually it just makes a losing position bigger.

Averaging down turns one decision into two, and the second one gets made under pressure, when judgment is at its worst.

The original plan set a size for a reason. Adding to a loser quietly throws that plan away and replaces it with hope.

If the trade no longer makes sense, the answer is to manage it or close it — not to double the bet that it'll come back.