BID AND ASK PRICES – PART I
By Michael Craig
WHAT ARE BID AND ASK PRICES
In order to successfully trade covered calls, an understanding of the difference between the BID and ASK prices is crucial. The following segment will highlight the differences between these prices and how they can be implemented in any investment strategy.
The BID is the price someone is willing to buy the stock for.
The ASK is the price someone is willing to sell the stock for.
Therefore, if an investor wants to buy the stock or option, he or she will have to look at the ASK to determine the price to purchase. Conversely, if an investor wants to sell, he or she will have to look at the BID price. These two prices are almost always different, with the ASK being a higher price than the BID.
Why are the BID and ASK prices so important? The BID and ASK prices are important because they are the future prices of the stock you want to buy or sell. Looking at the last trade tells you the past price. Unfortunately, you cannot buy a stock for the last price it traded. You have to look at the future prices.
To find the BID and ASK price while using an online broker, just get a real time quote. The real time quote will show you the last trade, as well as the BID, ASK and volume. Volume is the number of shares or contracts traded that day. Investors need to use these numbers to make their decisions.
When trading covered calls, the BID and ASK price are the prices that investors should use for decision making. Since a difference of an eighth or sixteenth can make a difference while writing covered calls, the BID and ASK prices are vital.
Here’s an example:
Let’s say you want to write a covered call on XYZ corp. You see that the last trade was for $50 a share, and the $50 call for next month last traded at $4. This produces an 8% return, and you decide that you want to invest.
When you go to execute your transaction to buy the stock, you execute a MARKET order and you see that you just purchased the stock for $50.50, and when you sell your $50 calls you only receive $3.75 a share. This produces a yield of 7.43% if not called and 6.44% if called. A MARKET order will “fill” instantly, but the prices paid are usually in “favor” of the other party. Meaning, if you are buying you will pay more, if you are selling you will be paid less.
If you had looked at the BID and ASK you would have seen that the ASK for XYZ Corp. was $50.50, and the BID for the $50 calls was $3.75. By using these price in your calculation, you could have seen EXACTLY what this particular trade would yield. You can then execute a LIMIT order, entering the BID and ASK prices, instead of letting the MARKET dictate the prices. This will be explained in Part II on Wednesday.
This is a segment of the newsletter where we will attempt to answer questions about covered call strategy and procedures. If have any questions about covered calls and NOT about particular stocks send them to michaelc@winninginvestments.com.
