Every option on an exchange has two prices at any moment. The bid is the highest price someone is currently willing to pay. The ask (also called the offer) is the lowest price someone is willing to sell at. The difference between them is the bid-ask spread. The last traded price (LTP) you see on an option chain is simply where the most recent trade happened, which may be at the bid, at the ask or in between.
Spread = ask price − bid price
Liquidity is how easily you can trade a meaningful quantity close to the fair price. A liquid option has a small spread and lots of quantity waiting on both sides. An illiquid one has a wide spread, little quantity, and trades only now and then. The spread is the clearest single measure of liquidity.
Why the spread is a real cost
If you buy with a market order you pay the ask. If you then immediately sell with a market order you receive the bid. Even if nothing else changed, you lose the spread. This is a cost just like brokerage and taxes, but it never shows up on your contract note, so it is easy to ignore.
Two examples (multiply by the lot size to get the cost per lot; lot sizes change, so check the current one on NSE):
| Option | Bid | Ask | Spread | Spread as % of ask |
|---|---|---|---|---|
| NIFTY ATM call (liquid) | ₹150.00 | ₹150.10 | ₹0.10 | 0.07% |
| Far OTM stock call (thin) | ₹2.10 | ₹3.40 | ₹1.30 | about 38% |
In the first case the spread is almost nothing. In the second, if you buy at ₹3.40 and the bid stays at ₹2.10, your option is instantly worth about 38% less than you paid if you had to sell; the bid has to rise about 62% just to get back to ₹3.40. Wide spreads destroy small trades.
What makes an option liquid
- The underlying. NIFTY, SENSEX and BANKNIFTY options are far more liquid than most stock options. Among stocks, large companies such as Reliance Industries, HDFC Bank and State Bank of India are much more liquid than smaller ones.
- Distance from the price. Strikes near the money trade the most. Deep in-the-money and far out-of-the-money strikes are thinner.
- Expiry. The nearest expiry is the busiest. Later expiries, especially monthly contracts several months out, have wider spreads.
- Time of day. Spreads are often wider in the first few minutes after 09:15, when prices are still settling, and can widen around big news.
- Volatility. When markets move fast, sellers protect themselves by quoting wider spreads.
Reading liquidity from the option chain
An option chain shows the signs of liquidity even before you open the order book: volume (contracts traded today) and open interest (contracts still open). Here is today's NIFTY chain:
Look at the open interest on each strike. The strikes with the largest numbers are where most traders are positioned and where you will usually find the tightest spreads. As you move away from the highlighted at-the-money row, open interest generally thins out. The open interest guide explains what these numbers mean.
Open interest also shows where liquidity sits across strikes for BANKNIFTY:
Compare the tallest bars with the strikes at the edges. The strikes with very small bars may still trade, but expect wider spreads and less quantity at each price.
Why spreads exist at all
Much of the quoting in options comes from market makers and other professional traders who keep a bid and an ask on many strikes at once. They earn the spread as payment for standing ready to trade with anyone, and they take on risk while doing it: the price can move against them before they can hedge. The riskier and less traded an option is, the wider they quote. That is why the spread widens in fast markets, before big events and in contracts few people trade. It is not a trick played on small traders; it is the price of being able to trade immediately. If you are willing to wait, a limit order inside the spread lets you earn part of it instead of paying it, at the risk of not being filled.
Market depth and impact cost
Your broker's trading screen shows market depth: the five best bids and five best asks with the quantity at each. If you want to buy 20 lots but only 5 lots are offered at the best ask, the rest of your order fills at the next, higher prices. This extra cost is called impact cost. Large traders split orders into smaller pieces to reduce it.
Exchanges also cap the size of a single order (the freeze quantity). Orders above it are rejected or split, so check the current limit with your broker if you trade in size.
How to place better orders
- Use limit orders. A limit order sets the maximum you will pay or the minimum you will accept. In a thin option a market order can fill at a shocking price.
- Start at the middle. Place your limit at the mid-price (halfway between bid and ask) and move it a tick at a time if it does not fill.
- Prefer liquid strikes. If two strikes express your view, the one with tighter spreads and more open interest is usually the better choice; see the strike selection guide.
- Be careful with stop-loss market orders. A stop-loss that turns into a market order can fill far below your trigger in a fast market. A stop-loss limit order caps the price but may not fill at all.
- Count the spread in your plan. For intraday trades aiming at small gains, the spread on four legs (for example a straddle opened and closed) can be a large part of the expected profit.
Liquidity on expiry day and in stock options
On expiry day near-the-money index options are extremely liquid, but far OTM strikes trading at a few paise can have spreads that are huge in percentage terms. In stock options, liquidity drops sharply away from the nearest two or three strikes, and next-month contracts can be thin until the last week of the current month. These patterns are covered in the expiry day guide and the index vs stock options guide.
Common mistakes
- Judging a trade by the last traded price. The LTP may be minutes old in a thin option. What you can actually trade at is the bid or the ask.
- Buying cheap far OTM options for their low price. Their spreads are often the widest in percentage terms.
- Ignoring the spread in backtests. A strategy tested on last traded prices can look profitable and lose money in real trading once spreads are paid.
- Trading illiquid contracts in size. Getting in may be easy; getting out quickly when the market turns may not.