How to Place an Option Order - The right way to give your broker a telephone order for stock or index options

Correct options order entry is a critical factor in getting good fills when trading options. Here I start a discussion of how to properly place your options trading order with your broker over the telephone. We start with the simplest order, the straight buy or sell. Future columns will focus on spread orders, changing orders and checking on orders.

Options Trading Topic: How To Place an Option Order

Dear Options Trading FAQ:

The reps at the brokerage firm I use never seem to understand what I want to do. I get nervous when they try to rush me and things get muddled. Any suggestions?

Dread the Call

Dear Don't Dread:

Your anxiety is a common one. Option trading beginners are nervous enough about the position they are about to enter - put them in a fast-paced, unfamiliar environment and often there is confusion.

Do try to be careful. Misspoken words during option order entry can lead to serious money errors. Buys may be executed instead of Sells, Puts instead of Calls, etc. Remember, your broker will do EXACTLY what you say (whether you really meant to or not). Also, harried representatives have been known to be short on patience with confused order placers. Chalk it up to the poor upbringing of the reps, perhaps, but most customers have encountered a certain degree of rudeness early in their trading careers.

There is a set sequence of wording that Wall Street professionals use among themselves to avoid errors. Options orders are always "read" in this fashion. Clerks are trained from day 1 to listen for and repeat for verification the orders in the same way. If you, the public customer, adopt the same lingo, you'll be way ahead of the game. In addition to preventing errors in your account, you will win the respect of your options broker as a savvy, street-wise trader.

Here is the "floor-ready" sequence of an options order:

After identifying yourself and declaring an intent to place an option order, clearly say the following:

For a one-sided order (simple buy or sell of a stock option):

"Buy 10 Calls XYZ February 50's at 1 1/2 to open, for the day"
Always start with whether it is a buy or sell. When you do so, the clerk will reach for the appropriate ticket.

Next comes the number of contracts. Remember, to determine the money amount of the trade, you multiply this number of contracts by 100 and then by the price of the option. In the above example, 10 x 100 x 1 1/2 = $1,500. Don't ever mention the equivalent number of underlying shares. One client of mine used to always order 1000 contracts when he really meant to buy 10 options (equivalent to 1000 shares of stock).

Thirdly, you name the stock. Call it by name first and then state the symbol if you know it. Be aware of similar sounding letters. B, T, D, E etc., can all sound alike in a noisy brokerage office. Over-The-Counter stocks can have really strange option symbols.

The month of expiration comes next. Again, be careful. September and December can sound alike. Floor lingo uses colorful nicknames to differentiate. The "Labor Day" 50s are Sept options while the "Christmas" 50s are the December series. But don't get carried away with trying to use the slang. Don't ever use it to show off to a clerk. Simply use it for accuracy (e.g. "the December as in Christmas 50s").

Then comes the strike price. Read it plainly and clearly. 15 and 50 sound alike as does 50 and 60.

Name the limit price or whether it is a market order. Qualify it if it is something other than a limit or market order. For example, 1 1/2 Stop. Pet peeve of many clerks: Don't say "or better" when entering a plain limit order. That is assumed in the definition of a limit order. "Or better" is a designation reserved for a specific instance where one names a price higher than the current market bid-ask as the top price to be paid.

For instance, an OEX call is 1 1/2 to 1 5/8 while you are watching the President on CNN. He hints at a budget resolution and you jump on the phone. You want to buy the calls but not with a market order. Instead, you give the floor some room with an "1 7/8 or better order". Clerks use this tag as a courtesy to each other to let them know they realize the current market is actually below the limit price. This saves them a confirming phone call.

Next is the position of the trade, that is, to Open or to Close. This is the least understood facet. It has nothing to do with the opening bell or closing bell. It tells the firm if you are establishing a new position (opening) or offsetting an existing one (closing). Don't just think that by saying "Buy", your firm knows you are opening a new position. Remember, options can be shorted. One can buy to open or to close. Likewise, one can sell to open or to close.

If your order has any restrictions, place them here at the end. Examples are All or None, Fill or Kill, Immediate or Cancel, Minimum of 15 (or whatever you want). Remember, restricted order have no standing. Unrestricted orders have execution priority.

Finally, state if the options order is a day order or Good Till Canceled. If you don't say, the broker will assume it to be a day order only, but the client should mention it as a courtesy.

Very Important: Your clerk will read the order back to you in the same way for verification. LISTEN CAREFULLY. If you don't catch an error at this point, they can stick you with the trade.

Proper option order entry can mean the difference between a successful execution and a missed fill or a poor price. Doing it the right way can save you precious seconds. Further, it will mean a better relationship with your broker. The representative will act differently when he sees a customer who knows what he is doing. The measure of respect given to someone who knows how to give an order properly is considerable. After all, you've just proven that you "speak" his language.



Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Broker, Index Options, Stock Options, Options Order

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use.

Option Premium - Smart Money or Dumb?

Option Trading Topic: Option Premium: Smart Money or Dumb?

Dear Options Trading FAQ:

Help, I get confused when thinking about options trading! In some recent letters you say to look at the option premiums and go contrary to what is popular. Then, you go ahead and give other examples where you laud call option buying in certain stocks as "informed". Which is it, oh Option Guru?

For example, if the call options are priced higher than the put options, I myself would think it to be a bullish signal, but from your example :

>Here is an example from today (01/04/96):
>The SPX is 620. The Jan 610 put option is 1 5/8. The mirror-
>image call option, the Jan 630 is 1 7/8. The call here is
>actually priced higher than the put!! Quite bearish.

How is it *quite bearish*?? I would think since there are equal numbers of people thinking the equity price will go up or down, there is equal chance of it doing so, no?

Can't Get Contrary on Option Trading

Dear Can't Get Rich Trading Options If You Can't Get Contrary:

Let me start with the example you quoted. The analysis went in my mind as follows: "Ever since the Crash, the SPX Put option premiums have been highly valued (needed by institutional players as insurance). In a "normal" situation they will be bid higher than their respective calls. So I see that in this case where the calls are more expensive than the puts, something unusual is going on. In fact, my usual trigger level is when the calls and puts trade at the same price - here we have exceeded that. There is a bullish frenzy present that cannot last. The puts are undervalued and the calls overvalued. The imbalance in sentiment must swing back the other way - What would cause that? Why, a market downswing. So go bearish."

That turned out to be precisely right as market followers know. This thinking was predicated on the assumption that the SPX option players represented "dumb" money. That brings me to your initial question, How to recognize the option sentiment as right or wrong.

Traditionally, the bulk of option speculators are considered wrong-way thinkers. Many time-honored technical indicators are contrarily based on the action of option traders (Put/Call Ratio, Dollar-Weighted Put/Call, Premium Ratio, etc.). I would go along with that when it comes to large bodies of option speculators (i.e., index options as a whole, or total equity option put/call ratios).

When looked at in total, one should consider the sentiment revealed as possibly wrong-way. Mind you, the crowd is allowed to be absolutely right at times (as many "too-early bears" in this current market can attest to - that means you, Mr. Granville and Mr. Prechter!), but in the whole, it is not in the nature of any market to let the herd make unlimited tons of cash.

The work of Bernie Schaeffer, Larry McMillan, and others have shown, however, that in specific instances, "smart" (and I mean VERY SMART) money can be seen moving into certain options. Careful tracking of money flows and volume swells in equity options can tip one off to the placement of "smart" money. This "informed" option activity (in the absence of news) alerts the savvy option trader to upcoming news in the stock. Recent examples of this include the huge inflation of option premium in the Loral calls the night before the takeover announcement. That case was dramatic as the price of the options continued to RISE in the face of a downticking stock. Another example is the jump in the options of Roberts Pharmaceuticals. For days the call options acted unusually, then the stock jumped 4 points in a day. Subsequently, it was announced that there may be an important drug approval coming up.

Particulars aside, watching the action in specific equity options will forecast the crucial moves in the stock. Here we must consider unusual option activity (a jump in implied volatility, a huge premium in price over the theoretical value, a swell in put or call volume), in the absence of news, as an indication of what the insiders are doing. There is hardly ever any "big news event" in a stock that occurs in isolation. The option activity will tip you off first. There seem to be no secrets on Wall Street (Psst, Harriet, Now you know I'm not supposed to say anything, but your dad better buy some calls on my company by next Tuesday...)
Sometimes it is not at all easy to discern if option activity is "smart" and should be emulated, but the concept is valid. If you concentrate on stocks whose options suggest something is cooking, you start on a higher plane than the usual trader. Let the options work for you. Make sure you keep an ear open to what they are telling you.

More in future columns on advanced techniques on reading option premiums (divergences, non-confirmations, etc.)

PS. Often times, with "outrageous" premiums extant, the savvy option trader will play the stock itself rather than join the mania in the options. If you are wrong, there is a good chance for another go at it, unlike with the overpriced options where there is often no second chance.

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Pricing, Options Strategy

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use.

More Pegging and Capping of Options

Options Trading Topic: More Pegging and Capping

Dear Options Trading FAQ:

Hi. I know an options research firm that often talks about out-of-the-money call option accumulation at certain strikes that can act as resistance for a stock. The theory behind that, I thought, is that the market makers who sold those calls will hedge by buying other calls and sell stock whenever the stock gets close to moving above the level with the high call accumulation to try to keep those calls out-of-the-money.

But then, I had a trader and a market maker call me and tell me that that is not usually the case and that the market maker doesn't even care where the stock is really. I'm very confused. What am I missing? Should I be a...

Conspiracy Theorist or Trusting Soul? An avid options trader.

Dear Always be Both as an Options Trader:

Ah, the ever-present whispers of stock manipulation. Traders with large option positions have great incentive to influence the price of the stock (especially at expiration). One of the most popular Options Trading FAQ columns dealt with the tendency for stocks to land exactly on their strikes on expiration day. If you would like a reprint of the "Coincidence or Conspiracy" Q&A from Oct 25, 1995, please e-mail me.

Some background: Trader Blair Hull (interviewed in The New Market Wizards by Schwager pg.385) says that there is a natural tendency for stocks to finish at the strike. He did some statistical work that was quoted in the WSJ. A stock is about twice as likely to finish within a 1/4 point of the strike price at an option expiration than might be expected.

Why is this? As mentioned, it was covered in my previous Q&A on option trading, but basically there is great incentive to do so. The particular option strategies require a close to the strike finish in order to maximize profit. This can be done through "natural" tendencies or by outright manipulation such as pegging or capping. In your example, selling shares of stock to purposely keep the stock below a certain strike is called capping. There are rules expressively forbidding this activity, so it can be a touchy subject.

To answer your question more directly, the option trader and market maker are right. This sort of case is rare. What happens most of the time is that the market makers set their hedges at the onset of the positions. That is, when they have to buy or sell to meet a public order, they lay off the risk on the spot. They would adjust their portfolio either in other options or in the stock itself (long or short). They will keep the hedge going as well as they can so that movement in the stock will not hurt them (delta neutral). The risk to them comes in the form of a large gap opening where they don't have a chance to adjust the hedge (out of kilter).

There have been (and always will be) cases where the market maker will try to peg or cap the stock at the expiry. Blair Hull laughs at a recollection: "When I was a trader on the PSE, two smaller mm's wanted to pin the price of a particular stock to the strike. They wanted to sell the stock on the expiration date and make sure that all the calls and puts went out worthless. They enlisted the aid of a large market maker in this scheme. The large market maker agreed to join their group and pin the stock. Instead, he took the opposite position and took them both out of the game."

This sort of stuff is unusual but the potential may exist when certain calls or puts accumulate. Maybe that is what your option research firm is talking about. It makes for an interesting report by the analyst, but I would side with the trader and the market maker on this. In fact, in most things, one should usually trust the guys and gals "downstairs" more than the fat cats "upstairs".

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Valuation, Options Pricing

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use.