Papale on Order Types

By Steve Papale

I’m Italian.  In fact I love being Italian.  I love the food, the tradition, the language (I don’t speak it but I like the way it sounds).  We visited the mother land this summer and it was incredible.  We ate some of the best food ever and saw buildings that have been standing longer than the United States has been around.  However there is one Italian tradition that is a bit odd to me.  While most of the rest of the world celebrates Christmas with Santa Claus as at least a part of it, Italy it seems has a witch deliver presents down the chimney.  What’s that all about?  Got to be hard to get the kids to sit on the witches lap to tell it what they want for Christmas.

When trading either stock or options we have a variety of different order types we can use depending on market conditions, targets and risk tolerance.  A market order is simply executing the order at the best prevailing market.  If selling, that would be the best bid, if buying, the best offer.  In stocks with tight markets that is usually fine however in some options with wide markets there is the risk of giving up quite a bit of slippage.

Another popular method of order execution is the limit order.  Here the order is placed  with a predetermined price.  For example I might place an order to sell MSFT Dec 47 calls @ $0.80.  This is useful in the sense I know the price I am filled, however there is no guarantee I will get filled unless the options trade through that price.  Remember that trading at a limit price does not assure a fill.  Only if it trades above the price in the case of selling options or below a price if we are buying are we guaranteed a fill.

Retail traders do get priority over “professionals” at any given price.  In the above example if the calls traded at $0.80, we would get filled before a market maker or other professional.  In stock trading, Stops and Stop Limits orders are common and can be useful.  Both are ways to limit losses when markets go against the trade.  They are placed above the market for short positions and below the market on long positions.  If the market hits the price for a stop order, the order becomes a market order and executed at the best prevailing price.

In the case of the stop limit, the order becomes active when the price is touched, however it becomes a limit order at the stop limit price.  The obvious risk here is the market could trade away from the limit price and the order may not get executed.  Stops and Stop Limits are useful for  in  stocks but difficult for option trading.  Next week we will get into the pitfalls of using stops and stop limit in options trading and how we can get around them.

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