Explore Your Options
| Got a question about options? Tom Gentile is the chief options strategist at Optionetics (www.optionetics.com), an education and publishing firm dedicated to teaching investors how to minimize their risk while maximizing profits using options. To submit a question, post it on the STOCKS & COMMODITIES website Message-Boards. Answers will be posted there, and selected questions will appear in future issues of S&C. | 
Tom Gentile of Optionetics |
NOT GETTING FILLED
I live in Europe and I often place my orders outside of US market hours. I almost always use limit orders between the bid and ask. For example, I tried to buy a call option the other day, but I did not get filled because the stock opened almost $2 higher than the previous day. I know this is all part of the game, but it's frustrating to watch a potential trade go up by about 40% in two days and missing out because I didn't get filled. Is there anything I can do?
Some of your orders are not getting filled for two very important reasons. The first is due to the price or quote information used to set the limit orders. You are taking information from the prior trading session, but a lot can change overnight or over the weekend. If you want to buy a call option on a volatile tech stock, shares might open higher if the US stock market is strong that day. If the stock is higher than the previous day, the call options will have increased in value as well. If so, the limit order, which is based on yesterday's quote, is not going to get executed because the market price is now higher.
Second, any time you try to enter a limit order between the bid and ask price, there is a risk the order won't get filled. It's generally a rule to take a third of the spread and leave the rest to the market maker. If there is 15 cents between the bid and ask, try taking only a nickel and leaving a dime for the market maker. Even if you use this rule, there is no assurance the order will get executed. Another party must be willing to take the other side of the trade at your price.
So if a trader is trying to save a nickel or a dime by placing limit orders between the current bid and offer price, it is a give and take situation. Yes, orders that are executed will be filled at better prices. At the same time, there is also a risk that the order will not get executed at all.
The only way to make sure the order is executed is to place a market order rather than a limit order. Then the trade will be executed at the opening price. The disadvantage is that the opening price can often be the worst price if the stock is strong early, but weaker late in the day. The downside of the limit order is simply that the order doesn't get filled. It can be frustrating at times, especially when the stock moves in the anticipated direction, but that is simply a fact of life when using limit orders.
TRADING FOCUS
Is it better to focus on one strategy or learn and use a lot of different ones?
Some strategists use only one or two strategies, while others use a number of different ones. The best answer often depends on where the individual is along the learning curve. In the beginning, traders should develop an understanding of a variety of different strategies, but focus on only one or two. In addition, we recommend gaining experience with paper-trading first, and then move on to real-world trading. Once the strategist is producing consistent results with one or two strategies on paper, then the next step is to generate successful results with real money.
Going one step further, once the strategist can generate consistent profits with one approach, he or she might not feel the need to learn more. Or the strategist might want to develop a repertoire of different strategies.
Learning several strategies can add some diversification to a portfolio. If the strategist has become an expert on straddles, which produce the best results in volatile markets, adding some calendar spreads can help boost returns when the markets are trading quietly. While straddles work well when markets are going vertical, calendars do better in horizontal markets. In sum, the first step is to become the master of one strategy and after achieving some success, work on developing a range of strategies that work well in different types of markets.
TRAILING STOPS
I have read about using trailing stocks with futures, but not with options. Can you give an example?
A trailing stop is an excellent risk management tool for aggressive traders. Remember, a stop is a type of order that is placed with a brokerage firm that instructs them to exit a position at a certain point. A sell-stop is probably the most common. It instructs the brokerage firm to sell a customer's position if it breaks below a certain level. If I buy a stock for $52 a share, I might place a stop at $50 if I want to limit my loss to 4% or less. If the stock hits $50, I am stopped out of the trade.
A trailing stop is an order to exit the trade as the price moves higher or lower. Say I have an open position in the Xyz long 35 call that cost me $1.50 a contract. I want to limit my loss to 50% and so I have an initial stop-loss at 75 cents a contract. From that point forward, I can instruct my broker to place a trailing stop at 75 cents below the market price.
Now, suppose Xyz moves higher and the call is worth $1.60. The trailing stop is 75 cents below the market price and if the call drops to $0.85 or less ($1.60 - $0.75), the position is closed. If the call rises to $3.00, a move below $2.25 will trigger the stop. So the trailing stop is a sell-stop that shifts based on changes in the value of the call. It is a way to limit losses and also protect profits as the price moves in the trader's favor.
Originally published in the November 2007 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2007, Technical Analysis, Inc.
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