Options Markets: How Far Have Implied Transaction Costs Fallen?

A key trend in the options markets over the past 20 years is the decline in trading fees. In the early years, many brokerage groups charged $10 per trade. In the 2010s, it fell to $5 per trade, and today Robinhood and other platforms offer commission-free options trading.

But while the explicit costs of options trading have fallen to near zero, what about implicit transaction costs? We explored this question by examining how the average bid-ask spread in options markets has changed over time.

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We selected 20 companies that have traded in the options markets since 2000, including companies such as J&J, Amazon, Goldman Sachs, AT&T, and P&G, and then tracked each company over time and compared to how their average was distributed between supply and demand, on a percentage basis, shifted between 2000 and 2020.

To control for other factors such as open interest, volume, and strike price, we performed a matching procedure that averaged bid-ask spreads for the four types of options: calls and in-the-money puts and out of money calls and puts — for the 20 companies in question and only included results for those options that had less than a 10% change in their open interest / volume / par price.

We found that bid-ask spreads have narrowed on both the put and the put side. But transaction costs for in-the-money options (those where the strike price is less than the stock’s market price) have fallen more than their out-of-the-money counterparts.

Average supply-demand differentials per year

Inside the money
Out of money
Inside the money
Out of money
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-the-money calls had an average bid-ask spread of 5.57% in 2000. By 2020, their bid-ask spread had fallen 4.34 percentage points to an average of 1.23%. On the other hand, out-of-the-money calls had an average bid-ask spread of 9.38% in 2000. This had decreased to 7.06% in 2020, representing a drop of 2.32 percentage points during the previous 20 years.

This shows how market makers still charge option buyers significant commissions. In particular, market makers continue to earn sizable implicit fees from investors, especially those betting on terminal risk events, ie those who are buying out-of-the-money options.

Announcement for the VIX index and global indices and volatility-based trading instruments

Finally, to put this in the context of equity markets, stocks currently have a bid-ask spread of between 0.01% and 20%, depending on the size of the company and its trading volume . Thus, although bid-ask spreads have decreased in the options markets, they are still much higher than their equivalents in the equity market.

All in all, our results highlight how market makers can still generate huge returns from implicit transaction costs, especially for out-of-the-money options.

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All posts are the opinion of the author. Therefore, they should not be construed as investment advice, nor do the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.

Image credit: ©Getty Images / Luco Plesse

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Derek Horstmeyer

Derek Horstmeyer is a professor at the George Mason University School of Business, specializing in exchange-traded fund (ETF) and mutual fund performance. He is currently director of the new Financial Planning and Wealth Management major at George Mason and founded the first student-managed mutual fund at GMU.

Marc Favro

Marco Favro is a sophomore at George Mason University pursuing a Bachelor of Science in Finance. He is interested in financial markets and information related to trading and wealth management. He plans to pursue opportunities in investment banking after completing his studies.

Michael Yelland

Michael Yelland is currently pursuing a degree in finance. He is interested in financial markets and investments. After completing his university studies, he is interested in financial analyst, asset management and investment banking opportunities.

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