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Option Exchanges
The Smart Profits Report: Issue #108
Thursday, May 6, 2004
Option Exchanges: The New ‘Boston Market’ And How to Profit from It
By Karim Rahemtulla
Chairman, Mt. Vernon Research
When one option exchange offers a better price than another, a good broker gets the best. So it’s good news to us that a new Boston Options Exchange is quickly gearing up for action. That brings the total to six exchanges handling options. Ultimately it means six choices for us on most options. I say most because an exchange is not required to trade all options. The more liquid the option and underlying stock, the more participation by exchanges.
The new Boston Exchange opened in late February and is quickly adding contracts. As of mid-April it was up to 232 option classes including heavily traded names like Agilent, Microsoft, Pepsi, General Electric and such. It will be adding more companies steadily.
A Word To The Wise About Exchanges…
When a new exchange enters the fray, it often gives you better fills because it wants business and it’s willing to forgo some profits by actually filling orders at a fair price to get them. Can you believe that? There actually is a point in time when an options exchange actually operates like a legitimate and respectable business…
Before you start dancing, hold up a minute. There’s a catch here. Don’t expect the big benefits to last more than a couple more months. After that it’s back to fleecing the public along with the rest of the gang.
But until BOX, as the new exchange calls itself, has as much business to reassure itself that it’s one of the players now, the added competition should drive the level of fleecing down somewhat. Then, look out again…
Same Old Option Exchange Story, Same Option Cautions
I recall when the ISEX (Independent Exchange) opened last year. All of a sudden I was getting great fills on my trades. The ISEX narrowed the spread and the other exchanges either followed or lost business. Today, however, ISEX is just like its brethren, quick to show a good price and even quicker to back away from filling you at that price.
The exchanges that control the options markets are about as honest as the top-level executives at Enron were. They are there to make money, and that means you are going to get hurt unless you know what you are doing.
How do you know what to do to protect yourself? Three simple steps will lead you to the best prices you can get:
- Do not chase an option based on a recommendation.
The option price will move and you can bet your bottom dollar the market maker at the exchange is well aware that you and several others are simultaneously in the hunt for that particular option. Wait a day or two, and once the dust has settled, that option will come back down, unless the shares skyrocket simultaneously.
I have seen this simultaneous explosion of a stock moving fast even as my recommendation went out three or four times in the past decade. So, chances are you will get filled if you are patient. I am long-term focused. Some services that rely on technical analysis to zero in on momentum and short-term trades may see it slightly more often, but that’s when you need rule 2…
- Use limit orders only.
You will be surprised at how often you WILL get filled with a limit order below the offer. Most likely you will get filled at the end of the trading day. If you don’t get filled, be glad. You will not make money - or you will make much less money, not worth the risk - if you insist on getting filled at too-high prices.
- Be sure to direct your order to the exchange that is doing the most volume.
Having your order sitting at an exchange that has yet to trade any volume or one that is in cahoots with your broker will not serve your purpose.
Last But Not Least…
By the way, if you are using a broker, check his policy on fills. A very few firms are set up for options traders so that our orders are routed to the best prices. If your broker tells you he is one of them, then I suggest you follow the market and look at contracts trading after your order is in to see if you really are getting the best prices (see today’s Smart Profits Cribsheet below for details on where to get the price updates).
Finally, BE GREEDY. That means being patient. There is always another day and another play. If your advisor is not giving you picks that are liquid enough that you get filled, consider finding someone who will.
Good Trading,
Karim Rahemtulla
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Today’s Smart Profits Crib Sheet
- You can get option price updates with any good real-time quote service, including the one offered by the Chicago Board of Options Exchange (www.cboe.com). It’s work and you may not want to do this all the time - after all, that is why you pay a broker. But it’s in your best interest to check the hired help even if it’s only for a month.
- To learn more about options trading terms like “limit order” or “volume,” just visit our handy Smart Profits Glossary.
Related Articles:
- Limit Order Diligence - How to Limit Your “Excitement” for Winning Trades
- Market Maker Tactics: What Market Makers Really Do
- Margin: How to Turn a 10% Bump into a 50% Jump
