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This section covers the basics of how to place a trade, as well as some of the available options that even the more experienced trader may have forgottenPLACING AN ORDER One of the most stressful functions of the new trader is actually to place that first trade. Picking up the phone or turning to the brokers web site is, without a doubt, a time of considerable angst. After all, you are trying something totally new. There is seemingly an endless number of choices, you are on your own, and, if you mess it up, it could conceivably cost you a lot of moneyyour money. As you gain experience, you will settle into a style of order placing that works for you and your broker, often forgetting that there are many other ways that might possibly solve a particular problem. This section covers the basics of how to place a trade, as well as some of the available options that even the more experienced trader may have forgotten. To place a trade, you need to communicate several specifics to your broker. The following list is designed to introduce you to these specifics, although in no particular order. This list can be applied to a single asset trade (stock, call, or put), but will work just as well for any of the Optionetics-style combination (or hedge) trades. You will need to provide your broker with seven items of information: 1. Whether you want to buy (go long) or sell (go short) the security. 2. The underlying stock (and possibly ticker symbol). 3. The actual investment vehicle (stock, call, or put). 4. For an option, the particular month and strike (and possibly the appropriate symbol). 5. The number of shares or contracts. 6. The type of trade (market, limitand if so, what limit). 7. Whether you are opening a position (initially setting up the posi tionlong or short) or you are closing a position (selling an existing long position or buying back an existing short position). Some brokers and most web sites require you to provide the exact ticker symbol for your transaction. Other brokers will accept an order using a plain English description of your transaction. Personally, I much prefer to give the plain English description, as then I am exactly sure of what I am saying. Using the coded description (which you can search for on Optionetics.com) is just too easy to mess up, especially for a beginning trader or a semiactive trader (one who remembers the code from last week or month). For instance, AEQFI and AEQRI appear to be almost identical (at least with my handwriting!) and in fact are both options for Adobe Systems, ADBE. However, the FI is the descriptor for the June 45 call, while the RI is the descriptor for the June 45 putboth fine options, but hardly interchangeable. If you are using a broker that cannot look up the symbols (or remember themthey, after all, do this many, many times per day), then be very careful that you in fact have the correct symbolit is your money that is on the line. ELECTRONIC ORDER ROUTING SYSTEMS In a relative sense, electronic communication networks (ECNs) are fairly new. Changes in the 1990s made it possible for the small investor to get access to Level II data and compete with market makers through the use of ECNs. Level II quotes are one of three levels of the National Association of Securities Dealers Automated Quotations System (Nasdaq). Level I quotes provide basic information such as the best bids and asks for Nasdaqlisted stocks. Level II data provides investors with more detailed quotes and information, including access to current bids and offers for all market makers in a given Nasdaq-listed stock. Level III is the most advanced level and is used by market makers to enter their own quotes to the system. In order to utilize ECNs you need to use a broker who provides direct access to them. Most traditional online brokerages offer Level I quotes; only direct-access brokers provide Level II quotes. ECNs are little exchanges themselves. There are many competing bids and offers from every single stock on each ECN. This depends a lot on the interest in the stock you are following. For example, you might find little interest from ECNs in particular stocks and sometimes find no interest at all for certain issues. By default, you will find only the best bid and ask from every ECN displayed in the Level II window. Generally each ECN is able to communicate only within the same ECN. There are some intelligent ECNs, though, that take all other ECNs into account. You are, however, able to display your own bids and offers through ECNs. The major advantage of these networks is that your orders are sent directly to the market, with no intermediary involved. They are kept in an electronic environment. For example, assume you are attempting to buy 600 shares of Cisco on an ECN and someone is willing to sell 600 shares or more for $17. If you enter an order for $17, your order gets executed immediately since there is a matching sell order. If the seller would be willing to sell only 300 shares, then you would get executed on only 300 shares. Also, since ECN orders are kept in an electronic environment they can be immediately changed or canceled at any time. The electronic Island network is the most popular order route among day traders. It is very inexpensive and amazingly fast and offers tremendous liquidity. Some of the major rules applying to the Island network are that you can place your own bids and offers, there is no limit to the amount of shares you can trade, and you can place only limit orders. Also, Island allows you to enter price limits with less than one-cent increments. Some of the bigger stocks can be traded on the network as well as Island, accounting for a large percentage of the total trades made on Nasdaq. Archipelago is an intelligent order routing system. It has its own order book but is also able to communicate with other market participants. Archipelago is a very useful system for day traders. Whenever there are ECNs inside of your price limit, Archipelago is generally a very good choice. If there is a better price coming into the market, Archipelago tries to target that price. The network can only accept round lots for smart order routing, and if you get a partial fill it will keep resending your order until it is completely filled or you become the bid or ask yourself. The small order execution system (SOES) was developed in the 1980s and was made mandatory after the 1987 stock market crash. During the crash, market makers were ignoring their posted prices and therefore clients werent able to execute their orders. This system made it mandatory for market makers to execute orders at the market makers displayed price. It is for trading with the market makers only and cannot execute to ECNs. The small order execution system used to have many limitations to it, such as maximum number of shares that one could execute, as well as a time restriction for executing orders on the same stock. The biggest problem with it was that a market maker was required to execute only one SOES order every 15 seconds. However, with the introduction of the new super SOES system these rules have changed significantly. Market makers are now required to execute every order they receive up to the size they are displaying, unless they decide to change their offer. You can now execute up to 999.999 shares via the new SOES. Since market makers now have to execute every SOES order they receive it has made SOES executions much faster and it has become a very interesting route for day traders again. You cannot display your own bids and offers through SOES, and the old SOES system still exists for smallcap stocks. The other ordering system worthy of a mention is the Selectnet system, also known as SNET. SNET was developed by market makers in order to execute their trades electronically and to avoid the verbal communication process via telephone. Today Selectnet is available to direct-access traders as well. Using an SNET preference order you can send your order to every market participant available on the Nasdaq. As you evaluate any of these systems for your own trading, just remember order entry rules change quite frequently. Make sure to study your brokers manual very carefully before making any trades. ORDER MECHANICS When you call your broker to place an order, it is a good idea to have all of the important information written down in front of you. What factors are important to this process? You have to know the quantity, the month, and the commodity. If there are options, you have to know the strike price, whether you want calls or puts, and if there is a price. A fill refers to the price at which an order is executed. Lets review the important items that need to be specified depending on the type of order you are placing. 1. Order type. The kind of order you wish to place. For example, a delta neutral spread order. 2. Exchange. Sometimes you will choose the exchange where the order is to be placed (for futures and options). Often, however, you will simply choose best, which instructs the broker to send the order to the exchange showing the best price. The default in most cases is best. 3. Quantity. Number of contracts. 4. Buy/sell. Puts or calls (also include the strike price and expiration). 5. Contract. Name of the contract (e.g., T-bond futures). 6. Month. Expiration month of the contract. 7. Price. Instructions regarding price execution. Types of Orders Once youve decided to place a trade, you have to choose the type of order to place. There are two basic order types: market orders and limit orders. Market orders are generally not the preferred way to trade when you are trading options. By placing a market order, you are assured of getting the trade executed immediately, but at whatever price the floor chooses to charge you! You are, in effect, handing them a blank check. In reality, if you are trading a stock or option with much activity, the price that the broker gives you on the phone and the price the stock is trading at by the time the order reaches the floor (a few seconds or minutes later) will not be much different. However, thinly traded stocks and options may find a fairly large swing. Also, if your broker happened to give you a bad quote or you didnt hear it correctly and you place a market order expecting a similar price, you may be quite disappointed. You would choose a market order only if you absolutely, positively had to have the trade consummated right now, no matter what. Therefore, under most circumstances, the limit order is the preferred way to trade. Limit orders come in many forms, but the basic concept is that you want the trade filled only if it meets your requirements (primarily a price that you have set). This protects you in several ways, not the least being that it protects you from the floor traders (manipulating the prices just as your trade reaches the floor) and from yourself (making an error in calculation, reading, hearing, or whatever). In a limit order, you will typically give the broker a price for the trade. If it is a debit trade (you are paying money out of your account) that price is the maximum price that you pay, and if the trade is a credit trade (you are receiving money into your account), that price is the minimum amount you will accept. Note: If the stock is moving rapidly, you can always set a limit outside the bid-ask spread. For instance, if the stock is moving up and you want to be sure to buy it, you can set a buy price of $55, even if the bid-ask quote is $49-$50. Your broker should be able to get the stock (or option) even if it is moving, but you are protected from finding that the price is $60 or $70 by the time your order is filled. If the stock price does jump up to $70 by the time your order hits the floor, you, of course, will not be filled. But then not getting filled is probably a good thing, especially if it was trading at $50 only moments before. From that basic setup, there are a number of additional choices that can be made. The first set of choices revolves around the duration of your limit order. There are basically three choices at this time: 1. Fill or kill. The broker is instructed to fill the order immediately, or kill (cancel) the order. 2. Day order. This tells the broker to put the order in for the day; if it is not filled by the close of the market today, then cancel the order. This is by far the most common type of limit order for two reasons. First, if you dont otherwise specify, the broker will automatically place the order as a day order. Second, it protects you from forgetting that you have the order placed with the broker, and being surprised somewhere down the road when you get a fill notice on that trade you placed weeks or months before. There is nothing stopping you from placing a series of day orders, if the original order was not filled. If you forget to replace the order and circumstances change dramatically in your security, you will not be adversely surprised. 3. Good till cancelled (GTC). When you place such an order, your bro ker will simply put it into the system and forget about it until your criteria are met. At that time, the order will be filled. Most brokers do have a limit on GTC orders, and will automatically cancel them after some period of timetwo months, six months, and so on. You should inquire of your broker as to what their standards are. For instance, one of the brokerage houses I use will accept day orders only for spread trades. However, my particular broker will automatically replace a spread order each morning if I have entered it as a GTC order. (Ive been told this has something to do with their computer systems!) Beyond the basic formats, there are numerous specialized order formats that could be useful for the trader in given circumstances. The following list details a few of these formats, and the reasons for using them: 1. At-the-opening order. If you want to make sure that you buy or sell a stock or option at the beginning of the day, you would place an atthe-opening order. Whatever price is set at the opening is the price at which your order will be filled. Typically, you would place this order if you were expecting a large move in the stock based on overnight news. 2. Buy on close. If you want to buy the security for the closing price of the day, you would place a buy on close order. This is often used if you are short a put or call on expiration day, there is a lot of time value still remaining in the option, and you dont want to either purchase or deliver the actual stock. By placing a buy on close order, you will suck out the entire premium, and avoid being assigned on your short option position. 2. Buy on opening. The buy side of the at-the-opening order. 3. Cancel former order. If you have previously placed a limit order, it hasnt yet been filled, and you now want to cancel it, you would place a cancel former order. 4. Exercise. If you are long an option and you either want the stock (if you are long the call) or you want to sell stock you own (if you are long the put), you would exercise your option. You would choose to exercise the option as opposed to either buying the stock and selling the call or selling the stock and selling the put if there was no time value in the option (typically if the option is deep in-the-money). You will then get the strike price of the option (buying or selling) no matter where the stock is presently trading, and with no slippage for the spread between the bid and ask prices. The exercise of the option takes place after the market has closed for the dayit doesnt happen immediately. 5. Market-if-touched (MIT). This is an order that automatically becomes a market order if the specified price is reached. This is frequently done as a form of protection for falling prices if you are long the stock or call, or rising prices if you are short the stock or long a put. Although it will not absolutely protect you (the market price could slam down through your price and keep on going before it can be executed, or conversely it could touch the price and then rebound, but still force you out of that trade), it can be useful in some instances. This order can be used either to close out an existing long or short position or to create a new position (if you only want to buy XYZ Corporation if the price dips to $X). 6. Buy stop order. Set a price (usually lower) than the current price, and if the market price falls to that specified price, the order becomes a market buy order. This is the same as the market-if-touched order, but specifically to repurchase a short position. 7. Sell on opening. The sell side of the at-the-opening order. 8. Sell stop order. Set a price lower (as protection) or higher (to capture a profit) than the current price, and if the market price reaches that price, the order becomes a market sell order. This is the same as the market-if-touched order, but specifically to sell your position. Placing an order is not a simple process, especially for the beginner. The variations are many, and the consequences of being wrong are great. This is why, when asked by new traders about the type of broker to get, I strongly recommend a full-service brokerthey can and will take the time to walk the novice trader through the intricacies of the system, generally protecting the traders from themselves. Even after many years of trading, I still find a full-service broker very helpful, especially when I am trying to do anything out of the ordinary, anything that is new to me, or something that I havent done in some time. |
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