The Problem With Option Limit Orders.
Posted by Pete Stolcers on November 15, 2010
Option Trading Question
Today Don G. states, “I don’t like to place market orders because I always seem to pay more than I should. However, when I place a limit order I rarely get filled unless the stock moves against me in a big way. What can I do?”
Option Trading Answer
This problem is very common and it has to do with the poor liquidity in many option markets. In particular, option series where less than 100 contracts have traded for the day. These bids and offers are a mile wide and they are being put up by an auto quote system that belongs to a Specialist/DPM. There are a handful of firms with deep pockets that provide this function and each stock is assigned to a member by the exchange. If it’s ill liquid, “you’ll take what you get and like it”.
Here’s an example. Recently, I put out a report to purchase the July 95 puts on a stock for $1.50. The stock was at $97.50 and the option market was $1.30 x $1.50. That was a big $.20 “edge” (15%+) and I was willing to give it up on a stock that had already traded 1M shares (very liquid). We got filled on a few options and then the Market Makers bumped up the offer to $1.55 without the stock moving. The stock did drop to $97 and the options were out of range for a while. As subscribers placed their $1.50 limits, they were in the “book” where everyone could see their bid. The stock rallied to $98, $.50 higher than when the options were $1.30 x $1.50 and we could not get filled. The market was $1.50 x $1.55 (our bid). The options were sitting there and the Market Maker was leaning on our bid as long as possible. When the stock finally got to an unbearable level where the trade was too good to pass up, they took us out. While this was happening all of the other exchanges had market’s of $1.30 x $1.55. They never locked with our bid to forced a fill. That is because the auto quotes are based on where the other Specialist quotes are when there is a public order. Sound unfair? It is. Right after we got filled the market went $1.20 x $1.40.
So how do you get around this? You cancel your order. If the Specialist/DPM knows that the order is not “dead meat”, and they can’t lean on it, they will be more likely to fill it when it is at a “fair” price knowing that you might go to another exchange. This means you have to cancel and re-enter it.The other way to correct the problem is to route the order to another exchange. Go from one to another and shop the order. You’d be surprised at the fills you can get. The final solution… trade the stock. Don’t give up all of your edge to the Specialist. If that solution doesn’t work for you, don’t do the trade. You need to be in a fair marketplace, not somewhere where you are going to get raped coming and going.
If an option is ill liquid and you want to try and shave a dime off of a $.30 wide market, you can try, but don’t leave the order out there. Cancel it if you are not filled right away. If the stock moves and your price has “come in” grab it. On ill liquid options your chance of getting a fill between the bid/ask is slim.
In a liquid stock you have a chance of trading against someone other than the Specialist and the markets are much tighter. You might even get filled between the bid/ask.
If you’ve had similar issues, share your experience and I’ll try to coach you on how to “work” the order.