A significant trend in options markets over the past 20 years is the decline in trading commissions. Initially, many broker groups charged $10 per trade. In the 2010s, that quantity dropped to $5 per trade, and today Robinhood and other platforms offer commission-free options trading.
But while the specific costs of options trading have fallen to almost zero, what concerning the implicit transaction costs? We addressed this query by examining how the common bid-ask spread in options markets has modified over time.
We chosen 20 firms which have traded in the choices markets since 2000, including firms like J&J, Amazon, Goldman Sachs, AT&T, and P&G, after which tracked each company over time and compared their average bid-ask spread on a percentage basis shifted between 2000 and 2020.
To control for other aspects equivalent to open interest, volume and notional price, we performed a concerted procedure that averaged the bid-ask spreads of the 4 option types – in-the-money calls and puts and in-the-money calls and puts – calls and puts – for the 20 firms in query and only included results for those options whose open interest/volume/notional price fluctuated lower than 10%.
We found that bid-ask spreads for each puts and calls have decreased. But the transaction costs of “in-the-money” options — options where the strike price is lower than the market price of the stock — have fallen greater than those of their “out-of-the-money” counterparts.
Average bid-ask spreads per 12 months
| In the cash Calls |
broke Calls |
In the cash Puts |
broke Puts |
|
| 2000 | 5.57% | 9.38% | 4.82% | 10.33% |
| 2005 | 4.06% | 9.25% | 4.85% | 10.24% |
| 2010 | 2.11% | 6.06% | 1.69% | 6.60% |
| 2015 | 2.38% | 6.23% | 2.71% | 6.36% |
| 2020 | 1.23% | 7.06% | 1.28% | 8.36% |
For example, in 2000, in-the-money calls had a median bid-ask spread of 5.57%. By 2020, their bid-ask spread had fallen by 4.34 percentage points to a median of 1.23%. On the opposite hand, out-of-the-money calls in 2000 had a median bid-ask spread of 9.38%. This had fallen to 7.06% by 2020, a decrease of two.32 percentage points in comparison with the previous 20 years.
This shows that market makers still charge options buyers significant fees. In particular, market makers proceed to charge significant implicit fees to investors, particularly those that bet on tail risk events, i.e. those that purchase far out-of-the-money options.
Finally, to place this into the context of stock markets, stocks currently have a bid-ask spread of between 0.01% and 0.20%, depending on the dimensions of the corporate and its trading volume. Even though bid-ask spreads in options markets have fallen, they’re still well above their stock market equivalents.
Overall, our results illustrate that market makers can still generate huge returns with implicit transaction costs – especially with options which are well out of the cash.
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Photo credit: ©Getty Images / Luco Plesse
