Ken Paddison |
In the current volatile market conditions the spread on the bid/ask of options has widened to reflect the uncertainty that traders are feeling. Now, more than ever you need to be disciplined when placing orders. See chart 1 for an example of an illiquid share whose options have low Volume and Open Interest as well as a wide Bid/Ask spread compared to the strike price.
click to enlarge
Have you ever placed a “Limit” buy order and thought, “well that’s a perfectly reasonable price” and never got filled? In this article I will discuss order types and the “special” difficulties that often face options traders when dealing with a Market Maker. However, some of the points are relevant to all traders. Here are some of the basics.
- Always use a limit order. Never, use a market order when opening an options trade. Using a market order literally means you’re giving the market makers free money, you will get filled at the worst possible price that they are allowed to give you. If you are placing an order when the market is closed because you can’t be there on the open, then consider this. Most electronic trading platforms allow you to place contingent orders. That is, the order won’t be placed unless certain criteria are met. It could be as simple as saying “I don’t want this trade if the share opens above/below a certain price point”. This is especially important in placing option spreads.
- Use day orders to enter a trade. Never use a good-till-cancelled order to enter a trade. If you don’t get filled today, then you may forget about that order and end up with a nasty surprise a few days later. A share or index can gap up or down dramatically overnight, and if you have a GTC order just sitting there, it will get filled if the market moves in the wrong direction, leaving you with a potentially worthless trade.
- Don’t overpay. If you place an order and get filled instantaneously, then most likely you paid too much. Basically, an instant fill means you have probably just given away a few cents needlessly. The bigger the trade, the more you lose, it’s worth while to spend an extra few minutes to see where the real price is, especially in illiquid markets. Always place your initial order just above the current bid and see what happens.
- Split up your order if you can. This will depend on several factors. If you’re paying per contract and not a flat fee for every order, then from a brokerage standpoint, it doesn’t matter if you place an order for 1 contract and do it 10 times, or place one order for 10 contracts.
- You can be cheap but you need to be flexible at the same time. This is a negotiation. Unfortunately, most of the time you are trading against a giant computer that is matching orders from all the exchanges. Remember, computers don’t get tired or hungry and they definitely don’t care about you, so if you’re trying to fill a trade and nothing is happening, then either the market will have to move in your favour, or you will have to adjust your price. You should have already decided what is the most that you are prepared to pay for this trade.
- Learn how to use your Brokerage Platform. There is nothing worse than needing to do something in a hurry and not having a clue what to do or where to look on the platform. Brokerage platforms vary greatly as far as what can and can’t be done on them in relation to placing orders, especially option spreads. Take the time to know your platform.
Remember, you always have options
Ken Paddison
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