Bid-Ask Spreads and Slippage: Enhancing Execution Quality in U.S. Equity Options

Have you ever had the experience, when trading US stock options, of seeing a price but finding the execution price fell short of your expectations? This price difference may be due to two key factors: bid-ask spread and slippage. Both not only affect your trading costs, but also directly impact your overall options investment return. In this article, we'll take an in-depth look at how bid-ask spreads and slippage work, plus share practical strategies to help you execute US stock options trades more efficiently and reduce trading costs.

What Are US Stock Options?

US stock options are a type of financial derivative based on US-listed stocks. They grant the buyer the right—but not the obligation—to buy or sell the underlying stock at a predetermined price within a certain period.

There are two main types of US stock options: Call Options, which give the buyer the right to buy the underlying stock at the specified price; and Put Options, which grant the right to sell at the specified price. Each contract typically represents 100 shares of the underlying stock.

What Is the Bid-Ask Spread?

The bid-ask spread is the difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask) in the market. This spread represents the cost of liquidity in the marketplace and serves as the profit margin for market makers providing that liquidity.

How the Bid-Ask Spread Works

Suppose the bid price for an option contract is $1.00, and the ask price is $1.60. The bid-ask spread in this case is $0.60. If you submit a market order to buy, you execute at $1.60; if you sell at market, you transact at $1.00. The $0.60 difference is the cost you pay for immediate execution.

The size of the bid-ask spread is mainly determined by:

Market Liquidity: Options with high trading volume and active buyers/sellers generally have narrower spreads. By contrast, thinly traded options often have wider spreads.

Market Volatility: During periods of significant market volatility or major news releases, market makers may widen spreads to hedge against increased uncertainty.

Trading Hours: At the market open and close, spreads tend to be wider because there are fewer participants and less liquidity.

How the Bid-Ask Spread Impacts Trading Costs

The bid-ask spread directly increases your trading costs. For instance, if you immediately buy and then sell the same contract as in the example above—without any market price changes—you would lose $0.60 per contract, which is 37.5% of your investment (calculated by the $1.60 ask price).

For short-term traders, the impact of the bid-ask spread is especially significant. Frequent trading means multiple instances of "paying the spread," and the accumulated costs can seriously erode profits. Therefore, choosing highly liquid options with tight bid-ask spreads is the first priority for controlling trading costs.

Tip: Traders may consider reviewing the bid-ask spread before trading and avoid contracts with excessively wide spreads. As a rule of thumb, spreads above 10% of the option price should prompt closer scrutiny.

What Is Slippage?

Slippage refers to the difference between your expected transaction price and the actual price at which your trade is executed. Even if you set a desired price using a limit order, market volatility or lack of liquidity may prevent your order from filling at that price—or from filling at all.

Causes of Slippage

Slippage typically arises in cases such as:

Increased Market Volatility: When the market is moving rapidly, the price can change between your order submission and execution, causing your fill price to deviate from expectations.

Lack of Liquidity: For options with low trading volume, the market depth is limited. If your order size is large, it may take multiple price levels to fill your order, resulting in an average fill price worse than expected.

Order Type Selection: Market orders guarantee execution but not price—so slippage tends to be worse in illiquid markets. Limit orders give you price control but don't guarantee execution, so you may risk missing a trade if prices aren't reached.

How Slippage Affects Options Trading

Slippage can impact all stages of options trading: entry, adjustments, and exit. Every transaction may be subject to slippage, and if your strategy requires frequent adjustments, cumulative slippage costs can become substantial.

For example, let's say you want to buy an option at the midpoint price of $1.30, but the bid-ask spread is $1.00–$1.60. With a market order, you'll fill at $1.60, resulting in $0.30 of slippage. That may not seem like much, but if you're trading 10 contracts (1,000 shares), your slippage cost amounts to $300.

For deep in-the-money or deep out-of-the-money options, low trading volume and order book depth make significant slippage even more likely. Larger market orders for such contracts may fill at prices far from the quoted midpoint.

How to Reduce the Impact of Bid-Ask Spread and Slippage

Understanding how the bid-ask spread and slippage work is only the first step—the key is taking practical measures to limit their impact. Here are several common methods.

Choose Highly Liquid Option Contracts

Liquidity is the foundation of lower trading costs. Liquid option contracts generally feature:

High open interest

High daily trading volume

Narrow bid-ask spreads

Investors should consider mainstream stocks and index options, such as widely-traded index ETFs or mega-cap blue chips. These attract many market participants, making their spreads typically tighter and minimizing slippage risk.

By contrast, options for small-cap or less-followed stocks often suffer from poor liquidity. Even if the underlying stock is attractive, the high trading costs may present challenges for effective execution.

Use Limit Orders to Control Execution Price

A limit order lets you specify the highest buy price or lowest sell price you are willing to accept—crucial for controlling slippage. While a limit order doesn't guarantee execution, it is highly effective in preventing trades at unfavourable prices during periods of market volatility.

Tips for using limit orders:

Set a Reasonable Price: Refer to the bid-ask midpoint and make adjustments as needed depending on market conditions. If you want faster execution, shade your price closer to the ask (when buying) or bid (when selling).

Avoid Pre-market and After-hours Trading: US options markets are much less liquid outside regular hours, with wider spreads and more slippage risk. Unless you have a special need, trading options is generally best during regular market hours.

Split Large Orders: For large order sizes, consider splitting your trades. A big single order can drain all the liquidity at a price level, leaving you with poor execution prices on part of your position. Splitting into smaller batches may take more time but can reduce overall slippage.

Tip: In illiquid markets, limit orders are preferable to market orders and can help you avoid excessive slippage.

Choose Suitable Expiry Dates and Strike Prices

An option contract's liquidity depends closely on its expiration and strike price. Generally:

Expiration: Near-term monthly contracts tend to be more liquid than longer-dated ones. However, “last-day options” approaching expiry lose time value rapidly, increasing risk.

Strike Price: Options at or near the money (strike price close to the underlying stock’s current price) are usually most liquid. Deep in-the-money or deep out-of-the-money options often have lower volumes and wider spreads.

When choosing contracts, prioritize expiration and strike combinations with better liquidity if they fit your strategy—this will help reduce trading costs.

Watch Market Timing

Market conditions can have a significant impact on spreads and slippage. Pay particular attention to these times:

Around Major Announcements: Earnings reports or Fed decisions bring more volatility and often widen bid-ask spreads.

First and Last 30 Minutes of the Trading Day: Spreads are usually widest at the open and just before close; it's often wise to wait for markets to settle.

Low Liquidity Periods: Holiday periods or trading lulls mean fewer participants and increased costs.

Trading during periods of high liquidity and stable volatility can greatly improve your fill rate and execution.

Practical Considerations for Bid-Ask Spread and Slippage

Theory needs to be combined with trading experience to be effective. Managing bid-ask spreads and slippage in actual trading requires attention to more granular details.

Assess the True Cost of a Trading Opportunity

When evaluating an options trade, it is important to evaluate more than just theoretical profits—deduct the bid-ask spread and potential slippage to get a realistic expected return.

Suppose an option strategy theoretically offers $500 in profit, but bid-ask spread eats up $200 and expected slippage is $100. Your true profit is $200. If commissions and fees take another $100, you’re left with just $100—your return shrinks substantially.

If the profit after all costs isn't sufficient, traders might evaluate whether the expected return remains viable after costs. “Don’t trade for trading’s sake”—that’s key to cost control.

Sensitivity of Strategies to Trading Costs

Different options strategies have varying sensitivity to bid-ask spread and slippage:

Short-term Strategies: Such as day-trading or swing trading. Frequent trading means costs make up a high proportion of returns. These strategies are extremely sensitive to the spread and require highly liquid contracts.

Income Strategies: Such as covered calls or cash-secured puts. These typically involve holding positions longer with fewer adjustments. While sensitivity to trading costs is lower, entry and exit costs should still be considered.

Directional Speculation: Trades based on market direction, usually held for periods between short- and long-term. Here, you need to balance trading costs with ideal execution timing.

Understanding your chosen strategy helps you adopt appropriate cost-control measures.

Risk Management Comes Before Cost Control

While managing spread and slippage is important, risk management always comes first. Sometimes, to stop a loss or lock in profit quickly, you may have to trade at a disadvantageous price, even if it means facing a wide spread or large slippage.

For example, if the market suddenly turns against you and your position faces major loss, executing a market order to close out may be an effective method to manage risk exposure—even if it means higher slippage. In such cases, protecting capital outweighs cost savings.

So, trade plans should always integrate both risk management and cost control, so you can make the right decision in every scenario.

FAQ

Is a Narrower Bid-Ask Spread Always Better?

Generally, narrower spreads mean lower costs and are better for investors. However, the spread reflects market liquidity: chasing only the tightest spreads may make you miss attractive opportunities in slightly less-liquid names. The key is to consider the spread as a percentage of the option’s price—if it’s reasonable and fits your strategy, a slightly wider spread can be acceptable.

How Can I Judge Whether an Option Contract Is Liquid Enough?

Look at these indicators: daily volume (hundreds of contracts or more is usually good), open interest (higher figures mean more market participation), and bid-ask spread (if the spread is less than 5-10% of the option price, that’s a sign of good liquidity). Consider these factors together for a comprehensive assessment.

Are Limit Orders Always Better Than Market Orders?

Both have their pros and cons, and the choice depends on your trading goals. Limit orders let you control price and avoid substantial slippage, which is useful in low-liquidity or volatile markets. However, they don’t guarantee a fill, so you might miss trades. Market orders guarantee execution, but not price, making them better for highly liquid markets or urgent trades. Use each flexibly according to the circumstances.

Can Slippage Be Completely Avoided?

Slippage is a fact of trading and can't be eliminated. However, you can dramatically reduce its impact by picking highly liquid contracts, using limit orders, avoiding high-volatility periods, and controlling order size. The goal isn’t to eliminate slippage, but to keep it within acceptable bounds so it doesn’t seriously affect your performance.

Why Do Limit Orders Sometimes Take a Long Time to Execute?

The main reason is your set price level hasn't been reached. When your buy price is below the market ask, or your sell price is above the market bid, the order remains pending until the market price matches. Also, if there’s a long queue at your price, your fill may be delayed due to order priority. If immediate execution is needed, consider setting your limit closer to the prevailing price.

Conclusion

Bid-ask spread and slippage are crucial cost factors in US stock options trading. The bid-ask spread reflects market liquidity and market makers’ margins, while slippage results from price fluctuations and insufficient liquidity. Both combine to affect your trading costs and ultimate returns. By choosing highly liquid options contracts, making use of limit orders, paying attention to market timing, and evaluating the true total cost of trades, you can effectively minimize the negative impact of spread and slippage on your results.

What tool or method you choose depends on your investment objectives, risk tolerance, outlook, and experience. Whatever you pick, make sure you fully understand how it works, its risk characteristics, and trading rules, and establish a robust risk management plan. For more investment knowledge, explore Longbridge Academy or download the Longbridge App.