Types of Orders

[Igor 10]

Placing an option order in a broker system is fairly straight forward, if a trader just wants to simply buy and sell. What most traders don't know is that they can tweak their orders to accommodate their investment strategies and avoid missing execution of their order (leakage). Traders hate when they miss a buying or selling opportunity due to an order not meeting demand during an auction. With a bit of knowledge on how to fine tune an option order, traders can rest easier knowing that the market will execute their request as planned.

 

What is an option order?

 

Whenever an investor wants to enter or leave the options market, they must place an order. Home broker systems send orders electronically to the market floor, where the stock market executes them, or not, at auction. An option order enters an auction list by price and time of day the trader placed the order. The more an option trades hands (volume), the better the chance an investor has to buy or sell it. Orders that are closer to an option's market price execute faster than those farther away.

 

Example: A trader wants to buy 100 options at $10.00 each. The investor places an order-to-buy in their home broker online system, where the brokerage house withdraws $1,000 from the investor's account and sends their request to auction. Let's say the market price is $9.99 and rising, and the investor's order is third on the auction list at $10.00. In a market order, as soon as the option's market value hits $10.00 or more, the investor's order will execute. If the investor placed the option order at $15.00, most likely the option's market value would not have reached the traders request by the end of the day. In that situation, the order would drop out of the auction, and the home broker would return the money back to the trader's investment account at the end of the day.

 

The Four Types of Orders

Basically, there are four types of orders, open, close, buy and sell, which are grouped as follows:

1. Buy-to-Enter the market: An investor buys options thinking the market price will go up.
   
2. Sell-to-Leave the market: An investor sells their options once the market price hits the investor's target.
   
3. Sell-to-Enter the market: An investor sells options, owned or to be purchased later for sale, thinking the market price will go up.
   
4. Buy-to-Leave the market: An investor buys options to cover short positions.
   

 

Fine-Tuning Orders

In each of the four cases above an investor can add more instructions to their orders, which can accommodate their investment strategies and prevent a loss in capital or leakage.

 

Market Order

Using this type of order, the trader's request executes immediately. Investors use market orders to get into the market quickly. The downside to this is that the investor must take the price given at execution. In low volume auctions, prices can vary considerably.

Example:

1) Market Order: buy 500 call options when it hits $10 = $5,000

2) Auction: 200 options available at $10, 100 at $10.20, and 200 at $10.30

Result: 500 options purchased immediately, regardless of price, resulting in multiple transactions totaling $5,080 (instead of $5,000)

 

Limit Order

Placing these types of orders put traders in full control of the buying or selling price. The order will not execute unless the option's market price hits the amount on the order request. The disadvantage to this type of order is that a trader's request may not execute, which would leave them out of the market. Also, a trader's order may only partially execute when placing limited orders.

Example:

1) Limited Order: Buy 500 put options at $10 =$5,000

2) Auction: 200 options available at $10, 1,000 at $9.99

Result: Partial execution resulting in buying only in 200 options for $2,000 (instead of $5,000)

 

Stop Orders

Sometimes investors like to limit or control their losses when they guess wrong. Placing a buy or sell stop order tells investors exactly how much they will lose if an option's market value swings in the opposite direction. Traders can request both market and limited stop orders.

Example:

1) Trader places an order to buy 100 call options at $10 = $1,000.

2) The order executes.

3) Trader places a limited order to sell 100 call options at $15 = $1,500 ($500 profit).

4) Not sure if the market is stable, they also place a limited stop order for the 100 options at $9 =$900.

Result: If the market falls, the stop order will execute at $9, and the investor will lose only $100 (1,000 - $900). The trader will also need to cancel their limited order at $15. Otherwise, a brokerage house could consider it an open-to-sell order (buying a put).

 

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