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Your article on butterfly spreads is appropriate for all markets, not just markets like today. However, I believe that you do a great disservice to the amateur readers to whom your analysis is addressed. At no point do you advise the reader to put the order in as a butterfly spread -- all three positions at once. A position you haven't completely established can go against you if the orders aren't simultaneously placed. Most importantly, you didn't advise readers to put the order in at a limit debit order. In the examples you presented, you showed a $1 debit for each of the positions. I looked at the prices for all six positions, and if you placed a market order you would have been clipped. The specialist would have a field day. Even limit orders very close to the ask (when buying) and very close to the bid (when selling) are impossible to fill, based on my experience. -- S.S.

These comments serve as a great follow-up to last week's Options Forum

in which I wrote about market orders and execution issues. The reader makes some excellent points and rightly takes me to task for not emphasizing possible pitfalls and how to avoid them when trading options.

I wholeheartedly agree with this reader that option orders, especially spreads, should be entered with price limits. I hope that omission wasn't construed as an endorsement of such a practice. All of the strategies I suggest provide prices that I believe are reasonable, attainable and create a position with an attractive risk/reward profile.

That said, it's worth repeating last week's message that the bid and offer prices appearing on your screen may not be an accurate representation of where an order will be filled. You should use limit orders whenever possible.

No Leg to Stand On

The next great piece of advice from our reader is that multiple strike orders should be entered as a single trade. That means the trade will be executed through the simultaneous transaction of all components of the order. Because of the aforementioned wide spreads (and occasional unsavory business practices) in some options markets, many traders, both retail and professional, resort to "legging" into positions.

This term refers to the process of executing one portion of a spread, then working in the other piece or pieces in the hope of attaining a better overall price. Unless you're a member of an exchange and are physically in the crowd, or you're a veteran options trader, do


attempt to leg in to positions. The chance of establishing a position on more favorable terms than the prevailing market is completely outweighed by the likelihood of the market moving away from you after you fill one piece of the position.

If that happens, you'll be forced to put on the remaining strikes at unfavorable prices. In the worst case, you'll be locking in a loss. In the best case, you will start behind the eight ball, and in some cases your thesis will need to be 100% accurate in order to become profitable.

TheStreet Recommends

While nearly all brokers, both traditional and online, will accept spread orders with price limits, how they are handled can vary from firm to firm.

Being Prepared

If you're going to be trading options on a regular basis, I recommend having an account with one of several firms that have carved out a niche by catering to options traders, including optionsXpress, WallStreet*E, Mr. Stock and Wall Street Access. These firms offer traders the ability to enter orders such as vertical spreads, strangles and butterflies with a specified price limit. The brokers (for when you need to speak to a human) tend to be knowledgeable about options, and they're equipped to answer questions and deal with problems.

Some mainstream online firms such as E*Trade and Brown & Co. also have been improving their option trading features and services.

But by far the biggest improvement has been the trend toward electronic trading. Leading the way is the International Securities Exchange. Launched in May 2000, the ISE is the first fully electronic exchange and it has already grabbed nearly 25% of all option volume. The Boston Stock Exchange will be launching the Boston Option Exchange, which will also use an all-electronic format, sometime this summer.

Earlier this month, the ISE introduced a new trading system, ISEspread, that allows members to automatically execute multiple-part trades against the existing order book.

"Rather than manually shopping a spread position around, ISEspread provides software that scans the regular order book, not just the spread book, increasing the possibility of being filled," says Steven Sears, ISE's director of research. While it's too early to supply specific data, Sears says there has been a noticeable pickup in the percentage of spread orders being filled.

Anecdotal evidence I've received from speaking with traders bears this out. "It's a huge advantage to be able to lift offers from the regular book and put together a spread rather than trying to find an exact match," says Mark Schwartz, chief options strategist with Chicago-based Infinity Trading.

Note that if you are an individual investor and you want to take advantage of ISEspread, you must tell your broker to direct your order to that exchange. As all the exchanges begin to link electronically, that won't be necessary. Customers will truly be shown the best bid and offer. But that's another story still waiting to be written.

Steven Smith writes regularly for In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to

Steve Smith.