How Does the Liquidity of an Option Contract Affect Its Bid-Ask Spread?

The liquidity of an option contract is inversely related to its bid-ask spread. Highly liquid options, which are frequently traded and have many buyers and sellers, typically have a very narrow bid-ask spread.

This narrow spread indicates a highly efficient market and a lower implicit transaction cost for the trader. Conversely, illiquid options, which are rarely traded, have a wide spread.

This wide spread reflects the higher risk and uncertainty for market makers and results in a higher implicit cost for the trader.