Many members of our BCI community have commented on the wide and, therefore, unfavorable bid-ask spreads that are published before the markets open and after they close. This article will explain this deviation and address how to manage these scenarios, explains Alan Ellman of The Blue Collar Investor.
What Is After-Hours Trading?
This is the exchange of securities outside the exchange’s normal trading hours (generally between 9:30 AM ET and 4 PM ET, Monday through Friday). Trading is facilitated by an electronic communication network (ECN), which allows buyers and sellers to match up their buy/sell orders for a specific security. After-hours trading starts at 4 PM ET and ends at 8 PM ET.
Pre-market Trading Hours
Pre-market trading begins at 8 AM ET and ends at 9:30 AM ET, when normal trading commences.
Volume and Bid-Ask Spreads During After-Hours and Pre-market Trading
There are far fewer players during these trading hours compared to normal market trading hours, and so the bid-ask spreads become much wider. This, along with potential for greater price fluctuations, creates more risk for investors. Those who do trade after-hours would make the case that opportunities can be created that may not be available when there is normal market trading volume.
How Are Bid-Ask Spreads Published?
The published bid price is the buy order with the highest price, and the published ask price is the sell order with the lowest price. Exchanges attempt to match these orders up. During normal trading hours with greater volume, there is a much better opportunity to execute these matches with little difference between the bid and ask prices. With the lower after-hours liquidity, there may be large gaps between the published bid and ask prices.
Why Are Spreads So Wide Before and When Markets First Open on Monday Morning?
When setting bid-ask spreads before the opening of regular trading hours, particularly on Monday morning, market makers might take some caution until they get comfortable with the direction of order flow for that day. This could explain wider spreads at the opening bell that tighten once the trading day has settled down. In other words, market makers will do their best to set implied volatility (IV) levels, but will have some uncertainty until orders start coming in. If the spreads are too tight, they might get stuck trading too much on one side of the market, which is exactly what they don’t want to do.
Option-Chain with Low Volume and Wide Bid-Ask Spreads
After-hours trading creates opportunities and higher risk than normal market trading. It is not appropriate for most retail investors, as institutional investors who engage in after-hours trading have more resources, making it problematic to compete against them. The best time to evaluate bid-ask spreads for our trades and to execute our covered call writing and put-selling trades is between the hours of 11 AM ET and 3 PM ET.
Learn more about Alan Ellman on the Blue Collar Investor Website.