Are You Shark Bait?

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by Gavin in Blog, option settlement
November 5, 2013 3 comments

Recently, I stumbled upon an excellent article regarding option order entry mistakes by Lee Finberg from Safer Trader . Mistakes with order entry happen to everyone, even the pros. I have had 2 occasions where I have entered a buy order instead of a sell order. One worked out in my favor the other didn’t, but still, I make doubly sure my order is correct these days before hitting that transmit button.

A lot of the points covered in Lee’s article are things that I talk about with coaching clients. Shark Bait problem #3 is one that I get asked about quite a lot. Let’s take a look at Lee’s list of 6 Option-Related Shark Bait Problems and their Solutions:

Shark Bait Problem #1: “I meant BUY!”

We’re semi-hardwired to say (or click) “sell” when exiting from a position. The problem is that if you’re attempting to offset your existing position to take a profit or prevent further hemorrhaging, “selling” when you have a short position will result in your doubling down on your position rather than exiting from it. Make this mistake and you now own twice as much of what you meant to own none of.

Shark Bait Problem #2: “Where the #$@! did this fill come from…”

You crafted your contingent credit spread order, checked it twice, and placed it. Now, if the Amalgamated Hysteria, Inc. (AH) underlying gets down to the chart support area you identified, your bull put spread order will be filled and you’ll have your desired position.

Uh oh. Ten days later, CNBC reports that the President of Amalgamated and the Chief Financial Officer have run off together to Bora Bora and much of the company’s money is missing. Good thing AH didn’t get down to your price the day you placed it so this crisis doesn’t affect you.

… except that when you crank up your computer to check your email today you find a cheery message from your brokerage that your AH order was just filled! You are horrified because AH has dropped from $68.50 before the news broke to $1.12 now… and trading has been suspended.

It turns out that when you placed the order ten days earlier, you did so as a “good-until-cancelled” order and, because it was far from your target price at the time, you forgot about it.

The moral: check your “open orders” every morning before the market opens. If you have good-until-cancelled orders, make sure you still want them in the market. Investing is not a set-it-and-forget-it operation.

Shark Bait Problem #3: “What do you mean my stop order was not filled!”

This one happens to many neophyte investors in stocks and options. After several experiences with stop orders that are filled at prices well off of the stop’s “trigger” price, the inexperienced investor discovers there’s such a thing as a stop-limit order.

The stop-limit order means that if the trigger price is reached, the stop order can only be filled at that trigger price or better. No more slippage.

The problem here is, of course, that if the market is plunging there may not be enough demand at your sell stop trigger price to fill your order, and the market continues to fall with you still in your position. This is not to say you cannot use stop-limit orders, but be aware that in situations where the market makes a sudden big move, you may not be filled on your protective stop if you specified stop-limit rather than the plain vanilla stop order.

Shark Bait Problem #4: “Good Grief! This reported fill price on my market order can’t be right!”

The last trade on the XYZ 80 call was at $0.92, and the last trade on the 85 call was $0.32. That’s a net premium of $0.60 and, to be sure I snag that net premium on my desired bear call spread, I entered an order to Sell the 80 call and buy the 85 call “at the market.”

Unfortunately for me, XYZ is thinly traded and the “last trade” option quotes were from 16 minutes ago; the current bid/ask on these options is much different because the underlying XYZ price has changed considerably since then. The result is that the fill on my options “market” order is much different from what I was expecting… and, of course, it’s usually unfavorably different.

Moral: the market order can bite you in an illiquid market. A tip-off to be careful about using a market order to enter a position is a wide bid-ask spread. A wide spread between the bid and the ask prices indicates low liquidity and an increased potential for a surprisingly unfavorable fill compared to the last trade price quote.

Shark Bait Problem #5: “What do you mean my order was not accepted!”

With options, expiration day and last trading day can have different ramifications.

On options based on stock and ETF underlyings:

        • Technical expiration day is the Saturday following the 3rd Friday of the month
        • Actual expiration day for investors is the 3rd Friday of the month

Last trading day is also the 3rd Friday of the month

On options based on Index underlyings:

Last trading day is the THURSDAY BEFORE the 3rd Friday of the month

Moral: If you need to exit from an Index position in the SPX, RUT, NDX, etc., do it before the close of trading on Thursday. You will not be able to do so on expiration Friday.

Shark Bait Problem #6: “Are you brokerage people out of your minds? ABC never traded at my stop price! I can’t be filled!”

Oh, yes you can.

There does not need to be a single trade at your stop “trigger price.” All that needs to occur to stop you out is that the bid or ask (depending on whether it’s a sell stop or a buy stop) reaches your trigger price.

In other words, a sell stop order means sell my position “at the market” if there is a trade at my trigger price or if there is a bid at that price.

This is the reason that “The Monthly Income Machine” technique exhorts you to place day-only stop orders after the market has already opened and been trading a while. It’s also yet another reason to avoid good-until-cancelled stop orders since stop orders become market orders if they coincide with bid/ask quotes at the opening as well as after trading is underway.

Just before trading begins, and at the opening itself, sharks toss Hail-Mary orders into the market that are far from real value. They’re hoping to land a fill from someone who has placed a market order that will be filled at the shark’s unwarranted price.

Moral: It is easy to avoid the shark. Just don’t have market orders (or stops that will become market orders if triggered) working in the market during the opening of the day’s trading.

Excellent article Lee, well said!

  1. Vlad says:

    Hi Gav, great resource, thank you. I actually follow Lee’s MIM and my Limit Stops get targeted even later on during the day sessions. Makes me tempted just to monitor the position without setting the stops. Any advise?

    1. Gavin says:

      I don’t use stops for option positions, I will use a price alert on the stock and then decide if I want to adjust or close the position.

  2. Ramsan says:

    Great advice!

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