Limit Orders a Must for Option Traders
02/19/2014 6:00 am EST
I have a confession to make: I am cheap.really cheap, says veteran options expert Ken Trester of Fast Options Profits.
Now, I don't mean to say that I skimp on quality. I just like to get the best price possible, no matter what I am buying-a car, an airline ticket, a hotel room-and I especially like to save when I'm buying options. The cheaper, the better!
My favorite options to trade are those that are undervalued, and thus, underpriced. I'm looking for those calls and puts that are ready to blast off into profitability, both alongside and even ahead of their underlying stocks. And the cheaper we can get them from the outset, the more upside we can enjoy when the trades start to move in our favor.
I have no problem with being called "cheap" when it comes to getting into an option trade just before it takes off, because when I'm cashing out of a winning trade, I'm taking home more dough than the guy who paid a lot more to enter the same trade!
Pay Less With Limit Orders
But what if you could pay even less for low-cost options trades?
Suppose you're interested in buying to open an option that has a "bid" price of $1 and an "ask" (or "offer") price of $1.30. To buy that option right now, you would need to pay $1.30, as that is the price that a seller is "asking" for.
But before you do that, take a minute or two to test the waters. If that $1.30 is the market price and you tell your broker to use a market order (i.e., to purchase the option immediately, no matter where it's trading) to buy that option, this is likely what you would pay.
Instead of a market order, take advantage of the fact that the options world truly is a marketplace—one where you can possibly get a better price just by asking.
How does that work? If you use a limit order (instead of a market order) when opening a position, you can tell your broker how much you are willing to pay to enter a trade.
Work Your Orders
For example, if you enter a limit price of $1.15, you can see whether the market maker will bite. You will be surprised at how many times you will get your price (i.e., $1.15) instead of the ask price of $1.30.
If your order at $1.15 is not filled after a few minutes, you can modify your order and pay the ask price by entering a market order or limit order at the ask price (that is, you can tell your broker to pay no more than $1.30).
It's worth it to take a few extra minutes and try to get a trade cheaper than you were planning to pay. What's the harm-the market maker can only say no, right? You might be surprised at what you can get, if only you ask for it.
That's the beauty of the limit order. When you're buying options, you choose the maximum amount of money you're willing to spend to enter each trade. And if the option trades below that level, you will get in on a discount because you're positioned to get that price or better.
Use Limits to Close
The same goes for when you're closing a position. You can also use a limit order to close the position when an option trades up to (or through) a certain price. For instance, suppose the option for which you paid $1.15 doubles in value to $2.30.
You can tell your broker to close the trade for $2.30 or better, which means it could be closed for $2.50, if someone is willing to pay that amount at the time your order is placed. And that translates into an extra 20 cents in your pocket- that's $20 per contract!
The only potential drawback is that if the option price does not trade at or below your order price, you won't get into that trade unless you revise your parameters. Just be careful to not overpay to get into a trade and to not take profits too soon.
I can spot a bargain-priced option from a hundred miles away, and know when it's time to jump on board or cash out of a particular play. But when it comes to making the most money on a winning trade, it's each individual's responsibility, and even prerogative, to seek the best prices possible to turn a winner into an even bigger success.
By Ken Trester, editor, Fast Options Profits