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Options Strategy for Calculating Limit Price on a Vertical Spread

Personal Finance & Money Asked on August 26, 2021

Is there a best strategy for calculating limit price on a vertical spread? Using the average of the bid and ask prices seems to lead to a lot of orders that do not get executed.

One Answer

It's more likely that you'll get a fill near the midpoint if the options have a decent amount of daily volume. However, that's no guarantee. I've seen liquid option series where they don't budge an inch as well as fairly illiquid ones where they split the bids more often than not.

When placing an order for a vertical, start at the midpoint. If you don't get a fill, gradually move the price away from the midpoint (higher if buying and lower if selling). Move price as much as you're willing to yield before concluding that the spread isn't desirable. If it's a must have position, you have to pay up. If you're seeking a good fill, you can work the order.

Be aware that the circumstances may affect your willingness to accept price current price or something close to it.

For example, in March I owned a lot of protective puts that went ITM. Since I wanted to maintain protection, I used vertical combo orders to book gains, rolling the long strikes down.

Because of share price volatility and because the long puts were ITM, a reversal in the underlying could result in losing a chunk of ITM profit. So at times, chasing a 5 or 10 cent better fill could result in losing much more on the long option. You have to weigh the trade offs.

Answered by Bob Baerker on August 26, 2021

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