Good job execution improves with experience, but it’s important to start with realistic expectations. Here are a few points to keep in mind:
The middle price is a starting point for estimating the fair value. Many traders expect to be filled “in the middle” every time, but this is not a realistic expectation and can lead to frustration. I usually start order entry with a contract. Depending on the bid / ask spread, I usually enter my limit order a little better than the middle price. I’ll give it 20-30 seconds to fill and then I’ll consider canceling / replacing.
Routing orders to different exchanges can be helpful. Before I change the price, I want to change the exchange the order is routed to (if the underlying is traded on multiple exchanges). Sometimes I also want to send multiple contracts to multiple exchanges for the same price. This really depends on how patient I want to be with the order. If a contract is executed on one exchange but not another, I can forward the other contracts to that exchange to try and fulfill the rest of the order.
Cancel / replace orders in steps to the bid / ask spread. For highly liquid products with relatively tight bid / ask spreads, I usually only move my marginal price by one cent. With less liquid basic products and / or complex multi-leg spreads with wider bid / ask spreads, I will shift my limit price more. Sometimes that’s a few cents, but it can also be as much as nickel or cents.
Fillings usually occur somewhere between medium and natural. My expectation in most options trading is that I will be filled somewhere between the midpoint and natural value. I will stress again that it is a best practice to start your limit price better than in the middle, as it seems from experience that electronic offers are occasionally out of date. If you get instantly filled better than median price, it is usually cause, and not a reason, to celebrate. Since there is no way of knowing when it will or not, it is best to start with an aggressive price and only part of your trade size to be on the safe side.
Getting too “picky” can be expensive. My last point comes back to my first as we need to have realistic expectations with our orders. The counterparty will typically be a professional market maker and they will be in business to provide liquidity against a profit margin. We have all seen the situation where we are unwilling to raise our marginal price and the market is drifting away from us. We know we’d better have conceded pennies to get filled than missed a profit. Of course, this is not discernible and therefore requires human judgment. Although the median price is often not a realistic expectation, it is seldom necessary to decide which bid or offer to use. Somewhere in between is a realistic expectation for most orders.
Take off short options if it’s nickel or less. Personally, I have traded on Think Or Swim through TD Ameritrade for more than a decade and there is a rule that short options can be closed commission free if they are nickel or less. Since commissions are one of the few things we can control when trading, I always keep this rule in mind when making exit decisions. Note that this rule does not apply when the trade is executed as a spread. So when you roll you want to close the short option first in a separate order and then sell the next leg in a separate second order. I asked to change this but it doesn’t seem to be going anywhere.
Always confirm before sending. It’s easy to get lazy and click through the ordering process a little too quickly without confirming before submitting. Occasionally, this leads to costly mistakes that need to be quickly reversed. For example, you could buy when you wanted to sell or sell when you wanted to buy. It’s easy to enter too many contracts or enter the wrong price when you end up with a lousy fill. It is best to carefully review the order confirmation screen and read the order out loud. This is especially true in volatile markets where the bid / ask spreads are wider than usual.
When it comes to options, it is important to be careful and patient while maintaining realistic expectations. While experience and certain order entry techniques, such as those outlined in this article, can improve your average price slightly, don’t expect magic. At the same time, careless market orders should be avoided and limit orders should be the standard in almost all cases. I usually assume that I need to cancel / replace my order a few times as part of the order fulfillment process, and then get filled about halfway between mid-price and natural price. For example, if I sold a put with a current bid / ask spread of $ 1.00 x $ 1.06, I could start my order at $ 1.04 and route contracts to multiple exchanges. I would expect to get filled around $ 1.02 on average at some point. Sometimes I’m lucky enough to get $ 1.03, and sometimes I have to settle for $ 1.01. What techniques have you found helpful in improving your order execution? Please feel free to add your thoughts in the comments section below for the benefit of the entire community.
Jesse Blom is a licensed investment advisor and Vice President of Lorintine Capital, LP. He is advising clients in the US and around the world on the plant. Jesse has been in the financial services industry since 2008 and is a CERTIFIED FINANCIAL PLANNER ™ professional. Working with a CFP® expert is the highest standard for advice on financial planning. Jesse holds a BS in Finance from Oral Roberts University.