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Option Trade Execution
The Smart Profits Report: Issue #123
Thursday, July 01, 2004
Option Trade Execution: Two Simple Steps for Getting Filled At Your Price
By Karim Rahemtulla
Investment Director, Mt. Vernon Research
There is nothing that bothers me more about electronic brokers than their poor option trade execution.
When I first began trading options I used a full-service broker. At the time, the cutting-edge technological advancement in this country was the touch-tone telephone.
There were only three exchanges that traded options and everything was priced in eighths and quarters.
Fast-forward to today… I now use both full-service and electronic brokers. For the purposes of this rant I am going to talk only about electronic discount brokers. Specifically, I’m going to talk about how they can route your trade to go against you - and how you can fight back using two simple steps…
Why Hatchets and Options Don’t Mix
I remember placing a sizeable covered call trade three years ago. I bought the stock first (you must do this in your retirement account - unless you do a “buy/write”).
Then I placed an order to sell the corresponding number of options. Well, the stock trade executed in seconds. The option trade, however, was not executed in a timely fashion. In fact, it was a complete hatchet job on the part of my broker.
I placed a limit order to sell the options based on the best bid, which was on Exchange A. (You have to remember that once you buy the shares on a covered call, you must sell the options pretty quickly in order to get your stated return. Any delay, and the trade could go against you. The share price could move lower and the option price may follow, reducing the amount of premium taken in.)
To my surprise, the order I placed showed up on Exchange B as the offer price. Imagine that! A bid and offer of the same amount!
In truth, an order to sell an option CAN appear as on offer, since I am putting up the options for sale. What should have happened is that my order should have smacked the bid on Exchange A - end of story.
A few minutes later, I called a live broker and asked him for a status report. He said - this is the technical term - “nothing done.” I proceeded to tell him that I was looking at the same screen that he was looking at and that my order should have been filled by Exchange A because it was bidding the same as I was offering. He said that he would check…
I waited.
How a Broker Can Route Your Trade Execution to His Advantage
While I was on hold, the bid on Exchange A fell by a nickel. Now, I would get at least 5 cents less on the sale - about 2% based on the transaction. I was not livid yet, but I was getting there.
He came back on the phone and said that my order was no longer at the bid. Well… No kidding!
I asked him why the order did not automatically go to the best exchange. And then it slipped out. His company automatically routed the executed trade to an exchange that it preferred.
Why did it prefer that particular exchange? One word: payola. The exchange was paying my brokerage a certain sum to have trades routed in its direction.
Well, needless to say I made the broker pull a time log that showed the time I placed the order and what all the exchanges were showing as bids and offers at the time.
And there it was in black and white: Exchange A was showing the same bid as my order. I was then filled by the broker even though the price had moved.
Two Steps to Avoiding Broker/Exchange Shenanigans
Ok. So what can you do to avoid or combat a similar situation?
- Use a full-service broker or the live broker at the discount firm and spend the extra five bucks to direct the trade to a specific exchange. If your broker won’t direct the order, then fire him - don’t hit the computer!
- Ask for an investigation into the transaction log. They might dissuade you by telling you it will cost $25 to do it or that they will check on it later. Insist on it and speak to a supervisor - their calls are taped and you should take notes with names and times. You will win.
Today, I make sure that I get my price either by making the broker very edgy by staying on the line until I am filled, or by using a specific strategy for covered call writing called a buy/write, which requires simultaneous execution at my limit prices.
More about this strategy another time. For now, be sure that your broker is on your side before you place an order. And don’t be shy about watching him like a hawk… It’s your money on the line, after all.
Good Trading,
Karim Rahemtulla
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Today’s Smart Profits Crib Sheet
- For definitions of terms like “buy-write“,”leverage” or “covered calls,” see the Smart Profits Glossary.
Related Articles:
- Buy-Write: Predict Your Profits With 99.7% Accuracy
- Limit Order Diligence - How to Limit Your “Excitement” for Winning Trades
- Become a Better Trader: Small Changes You Can Make for Big Profits
