On expiration week Thursday last week, I covered the short leg of a put credit spread. Friday morning at opening, I submitted a market order to sell the long. The market was quoted "no bid/$0.15 ask." After transmitting my order, this changed to "no bid/$0.05 ask" with an increase in offer size. I assumed that the first of those offered were mine. At the end of the day, several contracts traded at 5 cents, but none of mine were filled. My question is, when there is "no bid," is an option market order to sell placed in the limit book as if it were a 5-cent limit order? And more importantly, does a market order in such a case have execution priority over any limit orders (at whatever limit price) that were already in the book?
I don't know which was more awe-inspiring, the fact that this reader doesn't want to accept that at a nickel his options are "worthless" or that a market maker would actually try to "front run" a trade for a relative pittance. The awe for the former is for his diligence, while the awe of the latter consisted mostly of "is there no depth to which they won't sink?" disbelief.
My respect for the reader's question and sympathy for his cause prompted my initial emailed response, in which I wrote: "It was only $5 this time, but it would be wise to get a straight answer before a bad precedent gets set for the future when more money might be at stake." I suggested he telephone his broker for an explanation of the fulfillment procedure process and promised I would make some calls to get an "official" explanation.
Price and Time Rule, Size Does Not Matter
Just to make sure I was up to date and clear on the rules, I telephoned the various options exchanges and checked in with the
Options Industry Council, or OCC, which is always a great resource for all option-related questions.
The priority of order execution is based on the following:
A market order will be filled ahead of a limit order, as it will represent someone's will to sell at the bid or buy at the ask, which will be at "better" prices than the current market quote. The current market quote, which should be showing the "best" bid/ask spread, can be composed of market makers, customer limit orders, or a combination. Market makers are no longer held to a "10 up" market or required to fill 10 contracts at the displayed price.
This means every customer order should be shown to the market if it represents a better price -- that is, a higher bid or lower offer -- even if it is just one contract. If the market maker or specialist doesn't want to show your small "in between" order, he can take it out only by filling the order; once he cleans you out, he is free to repost his "market" bid/ask spread.
Orders are filled on a first come, first served basis. If two orders have the same price, the first one entered is the first filled, regardless of size. Even if you have just one contract to sell, it must be filled before any other orders can be executed at that price or higher.
Customer orders always take precedence over market maker or specialist transactions. A market maker or specialist must complete customer orders before executing any trades for their own account (or other broker/dealer accounts), unless they are improving the price.
For example, if the market maker is quoting $1.50/$1.80 and you place an order to sell two contracts at $1.70, the quote should move to $1.50/$1.70, and that order should take priority and be the first order to be filled if the option trades at $1.70 or higher.
The only time that size matters is between market makers. If two market makers, specialists or broker/dealers are all looking to sell an option at $1.50, and the best customer offer is $1.70, it will be the professional with the most contracts offered who gets priority, regardless of the time his offer was submitted.
No Bid or Not, They Owe You the Nickel
Although I can't speak for every brokerage firm's specific procedures, the three exchange representatives and OIC spokesperson I spoke with all felt that in a situation where there is "no bid," a market order to sell would be entered at 5 cents, or the minimum sale price.
Basically, if the broker didn't kick the order back to the customer, flagging the lack of bid or describing some limits (which doesn't seem to be the case here), the order is submitted at 5 cents and sits in the front row. The rest of those guys who were at 15 cents and tried to pile on your nickel order should only get filled behind you.
One other item to be aware of is that while decimalization has made them nearly obsolete,
cabinet trades do still exist and would allow for options to be bid or offered at a mere penny or $1 per contract for closing transactions. But cabinet bids and offers cannot be entered online; you will need to speak with a live person and let them know you wish to trade in the cabinet.
The example above did not trade in the cabinet, meaning the reader's price was not improved upon, meaning they owe him his fill at a nickel. To the reader I say, "A penny saved is a penny earned, and more power to you."
To the person who unfairly went ahead, I remind them not to be "penny-wise and pound-foolish" or be surprised when no one wants to trade in that crowd anymore and your job is eventually eliminated.
A Book for Your Thoughts
Looking for a good book on options that covers various strategies as well as potential effects on the share price of the underlying equities. Ideas?
It's been a while since I've suggested any reading material, and since you can never get enough learning, here are a few good books to prop up on your turkey-filled bellies. No dozing!
You can never go wrong with the classic
Option Volatility and Pricing
by Sheldon Natenberg. Ten years later, it remains a benchmark and one of the most popular books on options.
Profit with Options: Essential Methods for Investing Success
is the latest from Lawrence McMillan.
On my new recommended list is
Options and Options Trading. A Simplified Course that Takes you From Coin Tosses to Black-Scholes
by Robert Ward. Even though I still have about 50 pages left, I feel confident in saying Ward does a great job from beginning to end, clearly explaining the concepts behind all the math and probability theory and laying out useful trading applications.
So unless Ward closes the book with suggestion to sell a bunch of cheap options and send him a check with proceeds with a promise you'll get it back after expiration, I'd make room on your shelf for this recently published book.
I give thanks to all the readers and their terrific comments, questions and insight, and wish everyone a great holiday.
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Steven Smith writes regularly for TheStreet.com. 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