Hi
Subject 11 is still not finished, so let me move on with it: Entering the market.
Filling Orders
Apart from the different option orders, option traders must also take note of the 2 kinds of filling orders available. They are : 1. Market Order and 2. Limit Order. This is not peculiar to option trading but is something that confused as many option trading beginners.
Market Orders
By selecting to fill an option order using Market Order, you are telling the option trading broker to fill at the first available price on the market, regardless of how much that price is. This kind of order is ok for very liquid option contracts with very tight bid-ask spreads where prices don't change drastically. However, on less liquid option contracts, one could get filled at very high prices. The main disadvantage of a Market Order is that you will never know for sure what price your order will eventually get filled at, making trade management difficult. The actual filling price could be higher than what you first saw, thus requiring a margin of safety. That is why all option trading brokers requires you to have more money than necessary in your account in order to place a market order.
Limit Orders
By selecting to fill an option order using Limit Order, you are telling the options broker that you want to open the options position at no higher than a price that you determine. This kind of filling order eliminates the possibility of ever filling at any higher price than stated and therefore do not require a margin. The main disadvantage is that if the price has moved up while you are executing the order, the order may not be filled. In this case, if an order is not filled on limit order within a few seconds, you should check what the prevailing asking price of the option contract is and then modify the order accordingly.
Order Timing
Besides ordering your options broker to buy or write options based on market or limit order, you need to tell your options broker the timing of that order. Typical timing orders are Good Till Canceled (GTC), Day Order, Fill-Or-Kill (FOK), All-Or-None (AON) and Market-On-Close (MOC).
Good Till Canceled (GTC) ( Seems to be not offered in India )
A GTC order is an options order that remains valid until it is manually canceled and does not expire automatically at the end of the day. Good Till Canceled (GTC) orders are useful when establishing stop loss or profit taking orders that lasts for several days, weeks or even months. Most option brokers have their order screen default to GTC.
Day Order
A day order is an options order that expires when market closes if it is not filled during the day. This is useful for option traders who wish to enter at a certain fixed price for the day and if they don't get it, they would rather not take the position.
Fill-Or-Kill (FOK)
A Fill-Or-Kill order is an options order that cancels if it is not filled entirely upon execution. This is useful for option traders who are following a strict trade and portfolio management strategy that requires a full investment of every position.
Immediate-Or-Cancel (IOC)
An Immediate-Or-Cancel order is similar to the Fill-Or-Kill order but allows for a position to be partially filled upon execution and then cancel the unfilled portion.
All-Or-None (AON)
An All-Or-None order is an order that executes only if it is filled entirely. The difference between the AON and the FOK or IOC orders is that the order does not get cancelled if the position is not filled immediately and can be used in addition to a Day Order or a Good Till Cancelled order.
Market-On-Close (MOC)
A Market-On-Close order is an options order that fills a position at or near market close. This is useful for option traders who wish to close their expiring option positions on the last minute of expiration day. Market-On-Close orders are particularly popular for options writers who wish to maximize profits by allowing the last cent of extrinsic value to decay away from the position before closing it.
Exit Orders
After you have established the option position, it is time to automate that exit through stop loss or profit taking points. Option traders can completely automate stop loss or profit taking points in order to remove the involvement of human emotions through Stop Orders, Contingent Orders and Trailing Stop orders.
Stop Orders
Stop orders are the traditional stop loss mechanism used back in the old stock trading days. It is basically a price triggered sell order that closes your positions when a predetermined price is hit. Today, with the advent of contingent orders for options trading and all its flexibility, stop orders are fast diminishing in importance. The main and most significant drawback of Stop Orders is that it is activated only when a specific price is hit. If the option should gap past that price, it could continue lower without triggering the stop order!
There are 2 types of stop orders: Limit Stop and Market Stop.
Limit Stop
Limit stops, also known as Stop Limit Order, activates a limit order to sell when the stop price is hit. Again, this makes it an extremely insecure stop loss method as not only is the order triggered only if a certain price is hit, it needs to be able to fill at the price specified in the limit order, otherwise the position is free to continue falling!
Market Stop
Market Stops, also known as Stop Market Order, activates a market order to sell when the stop price is hit. A Market Stop order ensures that a position is sold, at all cost, when the stop price is hit. The drawback is, the filling price may be a lot lower than the stop order price.
Contingent Orders
Contingent orders are certainly the most flexible way to automate stop loss and profit taking. Contingent orders executes an order only when specific parameters such as an absolute or percentage change in the stock price or option price is fulfilled.
Trailing Stop Order
Trailing stop orders are orders that executes on a certain absolute or percentage change from the most favorable option price. An example of a trailing stop order is one which sells the option position when the option price retreats 10% from its highest price. The broker automatically updates the order continuously to the highest price of the option.
Roll
Most online options brokers have an option to "roll" your existing options contracts. This means closing off your existing options trading position and then opening a new position of the same size on the same underlying asset but with a further expiration month. This allows you to stay invested in the asset for a longer period of time. Read more about Roll Forward.(*)
Now you have a full list about the most common order types you can use in option trading. Next thing you have to have an idea about is how to give the broker an order over the phone. The following two pages shown below give you an idea about how this is done.
http://i43.tinypic.com/bd2fr.png http://i41.tinypic.com/20zslyc.png
The next link shows a simple order sheet. This just to give a basic idea, how such a sheet could look.
http://i40.tinypic.com/j6jsjk.png
Your broker should have a PDF about: How to place orders by phone or on line. Read carefully through it, especially through the section: Avoiding common pitfalls.
Thats it for today.
One more follow up on this subject will be made before we close it.
DanPickUp
(*) Source:
http://www.optiontradingpedia.com/types_of_option_orders.htm#order type
