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Limit Prices
The Smart Profits Report: Issue #175
Thursday, January 13, 2005
Limit Prices: Tip the Odds on Options Trades In Your Favor
By Karim Rahemtulla
Investment Director, Mt. Vernon Research
When I research and write a recommendation for one of my options-trading services, I get pretty excited. And I want my readers to be excited, too.
But I also want my trading-service subscribers - and you - to understand the difference between excitement and foolhardiness.
Investing is all about buying at the right price and selling at the right price… Excitement means you should want to buy or sell the options within the limit prices prescribed in the recommendation. Foolhardiness means buying at any price and selling at any price, thinking that the price will “get away” and the opportunity will be missed.
Here’s how to get the price you want, so you can see the profits you want from your next option play…
Using Limit Prices Is KEY
One of the observations I can make after trading for more than a decade is that 99% of my recommendations were and could have been filled at or below the limit price.
Sometimes it may have taken a day or two for this to happen, but it happened.
However, I can also say that 99% of the time, someone paid more than the limit price instead of waiting.
If you wait, the odds of you getting in below the limit price are 99 to 1 - IN YOUR FAVOR. So wait, if you have to, instead of buying at any cost.
Each Nickel in Price Equals $50 In Profits - Or Losses
For options this is especially serious, since every nickel that you overpay is HUGE in percentage terms. Because options trade in 100-share contracts, each nickel is equal to an additional $50 per trade.
So trust me, if you want to pay more, the market maker is more than happy to fill your order at a higher price.
How to Be Sure You Pay the Price YOU Want
How can you know that you will be filled at the limit price or lower? Here are a couple ways… Options pricing is based on a model that takes into account several factors.
One of the most important factors is the underlying share price. If you watch the underlying share price and you see it falling, then the option must also fall at some point - down to your limit price.
The other way you can be sure an option will tend to fall toward your limit price is the diminishing time value present in all options…
Benjamin Franklin once remarked that the only sure things in life are death and taxes. There is one more sure thing: Options are a decaying asset. Because they have an expiration date, the value of an option declines a fraction each day.
And, unless the underlying share price moves in your direction, you can bet that the price of the option will not acquire legs and start moving on its own away from your limit price…
If you can have a little patience, you’ll be able to get into your next option play at YOUR price - not the market maker’s. And buying at the right price is 50% of the battle when it comes to profiting from options.
Good trading,
Karim Rahemtulla
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Today’s Smart Profits Cribsheet
- limit prices“, “decaying asset” or “liquidity.”
Related Articles:
- Liquidity and Limit Orders: An Options Balancing Act
- Limit Orders vs. Naked Puts: Getting Paid to Place Them On Your Favorite Stock
- Writing Covered Calls: How to Double Your Stock Profits with Options
