In a Pinch, How to Use Limit Orders
Trading US options while not in the US.
Minyan NK writes:
How much of a better price can I expect to get with limit orders? I just started trading US options, but am based in Australia. I generally don't watch the market -- and work off yesterday's closing bid/ask prices.
I assume that you enter a limit order based on what you noted the night before. If you enter "market orders" please don't do that.
When trading options, entering such an order is an invitation to receive a terrible fill, and there's little chance that you'll get a fair price.
Entering a market order at the opening is much worse. It's difficult to imagine being so desperate to get a fill that you're willing to enter a market order at the opening of trading.
If you want to trade the opening, limit orders are mandatory.
Yesterday's closing bid/ask prices are almost always bad. By that I mean they no longer represent the true market the following morning. Why?
- Many times the market makers widen the bid/ask spread just before the closing bell.
- If the stock price changes overnight -- a common situation -- so will option prices.
- If implied volatility changes overnight -- and that happens frequently enough that it's a major factor in option pricing -- then the option prices may be significantly different the next morning.
If a market is very tight, such as 1.20 bid, 1.25 ask, then paying the offer is fine and won't cost you anything. But enter a limit order to pay $1.25 -- don't enter a market order.
If a market is wide, such as 2.30 bid, 2.60 asked, it's extremely likely you can buy at 2.55 and I'd estimate the chances of getting filled by bidding 2.50 are at least 50%.
Obviously this is going to depend on liquidity -- but most markets are wide for a reason. Foolish investors enter market orders or orders to buy at the ask price (when markets are wide). There's no reason for market makers to offer to sell at lower prices when people are willing to pay higher prices.
I suggest you begin by looking at the midpoint between the bid and ask prices. Then enter your bid $0.10 above (or your offer, $0.10 below) that midpoint. If you're quickly filled, then the next time you trade the options for that underlying asset, try entering the order $0.05 away from the midpoint.
If you're not filled with $0.10, then try $0.15 next time. This is truly a trial-and-error process. Conditions change and sometimes it's very easy to buy and sell options at favorable prices, and at other times, it's difficult.
I understand that the problem is you can't see "current" markets when you enter an order. That's not a good thing. Is there any way to be awake when the markets open (or perhaps near the market's closing time) -- long enough to enter orders that you decided to enter the night before?
If not, perhaps you can make an arrangement with your broker -- I'm sure they would charge a higher commission to do as I suggest. The broker can enter the order for the option you want to trade, at a price that is $0.10 above the midpoint when the market settles down -- say about 15 minutes after the opening.
The bottom-line answer is that you can do enough better by using limit orders to make it worthwhile. Enough better to lose a night's sleep? Probably not -- but that depends on how many contracts you trade.
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