Steve, I've been trying use options rather than stocks to trade for about a year now and it's been going OK. I like leverage and try to keep the positions straightforward. But I'm often frustrated by not being able to get an order executed and having to choose between not getting filled and placing a market order. Any tips you can suggest on execution?
"In order to attain a truly pleasurable and profitable trading experience one must strive for two things: good ideas and good execution."
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previous Options Forum I discussed some of the rules that govern order execution at the various option exchanges. I focused mostly on the market makers' responsibility to fill customer orders. But let's look at some steps you can take to improve both the percentage of orders filled and their execution price.
When a Dime Is a Dollar
A great advantage of trading options instead of their underlying shares is that they're cheap and provide leverage. But the downside to the low price and derivative nature becomes evident in the relatively wide bid/ask spreads, especially when calculated on a percentage basis. While options can give you "more bang for the buck" in absolute terms, the percentage returns can swing widely as a function of the execution price.
For example, say XYZ shares are trading at $30 and you decide to buy a September 30 call quoted as "$3.30 bid, $3.60 offer." You're bullish and decide to simply put in a market order and get filled at $3.60. The option has a delta of 50 and assuming volatility remains constant, the stock has to gain about 2%, or 60 cents, to reach the option break-even point. But if you were to buy the call for a dime less at $3.50, XYZ shares would only need to rise 0.006% or 20 cents, for you to break even on the options.
One of the simplest and most obvious ways to improve execution price is to trade active liquid option classes that are multiply listed. This means the option is traded on more than one exchange so that more than one market maker or specialist is making a market and competing for your order. As the options industry improves technology and integrates electronic execution, we have seen an increase in linkages across exchanges. More than 80% of all listed options are linked across multiple exchanges. This has greatly narrowed the bid/ask in most options and improved the customer's ability of seeing and receiving the best bid/best offer.
This isn't the case with certain index options like the S&P 100 (OEX) and
(SPX), in which the Chicago Board of Options has a monopoly. Even though they're actively traded, most strikes tend to have a fairly wide bid/ask. Currently, with the SPX index trading at 980, the August at-the-money 980 call is quoted $14.40 bid, $15.90 offer. If trading these markets, I'd strongly suggest using limit, not market, orders.
But with liquid issues that offer tight spreads, using market orders might make sense. Some traders break their order into pieces. They enter a portion "at the market" and the remaining contracts at a specified limit. This ensures that you'd get at least a partial fill and not miss the trade but also would help improve your average cost. Of course, a low commission structure and trading reasonable volumes are needed to make this economically beneficial.
Come In Late, Take Lunch Off, Leave Early
When possible, certain times of the day should be avoided for entering orders. I would not place market orders at the opening of the trading day. This can be a volatile time and despite premarket indicators, the opening trade on the underlying share can vary widely from its previous closing price. Wait through the first half-hour to see if the action settles and a trading range is established.
This also gives the option-market makers -- who, in an attempt to minimize risk, will initially post the widest allowable spreads -- time to narrow their bid/ask. The same holds true for the final 15 minutes of trading.
Lunchtime should be avoided because volume tends to fall as traders leave their posts to relax. Markets tend to widen during these quiet periods as the remaining market makers have less competition and feel no compulsion to take unnecessary risks.
Spreading Is Bettering
The placing and execution of spread orders has improved dramatically, due largely to new technology. Online brokerage firm OptionXpress offers Xspreads, which allows customers to enter multiple-part orders as a single transaction. It then posts this on the spread book, which can be seen by other traders. In the past, most spread orders were held in the specialists' book, where quotes were not widely disseminated and would only be filled when there was a matching order.
The new technology provides much greater visibility and will scan both the spread book and all other existing orders to try to fill the order. I recommend using these spread-order features rather than trying to leg into a position.
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