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Option Order Execution Tips


As a community of option traders, we all can relate to the occasional challenges of order execution. Best practices for avoiding errors as well as techniques for better potential execution will be the focus of this article.  Like countless others in the Steady Options community, I personally have traded thousands of option contracts over the last decade.

Good order execution improves with experience, but it’s important to start with realistic expectations. Here are some points to consider:

 

Mid Price is a starting point for estimating fair value. Many traders expect to get filled “at the mid” each and every time, but this is not a realistic expectation and can lead to frustration. I typically begin order entry with one contract, and depending on the bid/ask spread I’ll typically enter my limit order slightly better than mid price. I will give it 20-30 seconds to fill, and then I’ll consider a cancel/replace.

 

Routing orders to different exchanges can help. Before changing the price, I like to change the exchange the order is being routed to (if the underlying trades on multiple exchanges). Sometimes I also like to submit multiple contracts at the same price to multiple exchanges, this is really a matter of how patient I want to be with the order. If one contract fills on one exchange but not another, I might route the other contracts to that exchange to try to fill the rest of the order.

 

Cancel/replace orders in increments relative to the bid/ask spread. With highly liquid products that have relatively narrow bid/ask spreads, I’ll usually move my limit price by only a penny. With less liquid underlying products and/or complex multi-leg spreads that have wider bid/ask spreads I’ll move my limit price more. Sometimes this will be a couple pennies, but could also be as much as a nickel or dime.

 

Fills will usually occur somewhere between mid and natural.  My expectation on most option trades is that I’ll get filled somewhere in between the midpoint and the natural. I’ll again stress that it’s a best practice to begin your limit price at better than mid, as it seems from experience that electronic quotes are occasionally stale. When you get filled instantly better than the mid price, this typically is why and is not a reason for celebration. Since there’s no way to know when this is the case or not, it’s best to start with an aggressive price and with only a portion of your trade size to be safe.

 

Getting too “picky” can end up being costly. We need to have realistic expectations with our orders. The counterparty is typically going to be a professional market maker, and they are in business to provide liquidity in exchange for a profit margin. We’ve all experienced the situation where we are unwilling to budge on our limit price, and the market moves away from us. We realize we would have been better conceding a few cents to get filled than miss out on a profit. This is of course unknowable, and therefore requires human judgement. Although mid price is often not a realistic expectation, settling for the bid or offer is rarely required. Somewhere in between is a realistic expectation for most orders.

 

Take off short options when they are a nickel or less. I personally have traded on Think Or Swim through TD Ameritrade for more than a decade, and they have a rule where short options can be closed commission free when they are a nickel or less. Because commissions are one of the few things we can control with trading, I always keep this rule in mind with my exit decisions. Note that this rule does not apply if the trade is executed as a spread. So if you’re rolling, you’ll want to close the short option first in a separate order and then sell the next leg in a separate order. I’ve requested this to be changed, but it seems to go nowhere.

 

Always confirm before you send. It’s easy to get lazy and click through the order process too quickly without confirming before you send. Occasionally this causes expensive mistakes that need to be quickly undone. For example, you might buy when you meant to sell or sell when you meant to buy. It’s easy to enter too many contracts or enter the wrong price where you end up getting a lousy fill because you essentially entered a market order. A good practice is to carefully review the order confirmation screen and read the order aloud to yourself. This is especially true in volatile markets where bid/ask spreads are wider than usual like they were in March 2020.

 

Summary

With options, it’s important to be careful and patient while at the same time maintaining realistic expectations. While experience and certain order entry techniques like discussed in this article may modestly improve your average price, don’t expect magic. At the same time, careless market orders should be avoided and limit orders should be the default in nearly all instances. I usually start with the assumption I’ll need to cancel/replace my order a few times as part of the order execution process and will end up being filled about halfway between the mid price and the natural. For example, if I was selling a put with a current bid/ask spread of $1.00 x $1.06, I might start my order at $1.04 and route contracts to multiple exchanges. I’d eventually expect to get filled around $1.02, on average. Sometimes I might be fortunate to get $1.03, and sometimes I’ll have to settle for $1.01. What techniques have you found helpful with improving your order execution? Please feel free to add your thoughts in the comment section below for the benefit of the whole community.

 

Jesse Blom is a licensed investment advisor and Vice President of Lorintine Capital, LP. He provides investment advice to clients all over the United States and around the world. Jesse has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™ professional. Working with a CFP® professional represents the highest standard of financial planning advice. Jesse has a Bachelor of Science in Finance from Oral Roberts University.

 

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Thank you @Jesse this is a very helpful and practical advice.

One thing to consider when trading spreads is that the mid of the spread might not always be the "real" mid. For example, consider the following calendar spread:

image.png

The mid of the long option is 6.00, the mid of the short option is 4.90. Therefore, the real mid is 1.10. But since someone is bidding 1.02 on the spread, IB shows 1.41 as the mid, which is incorrect. For spreads, always calculate the "real" mid based on the mids of individual legs.

 

As a general comment, trading is a business. As in any business, prices are involved, and our profitability of success will always depend on our ability to get good fills. Every business revolves around this cost equation... If getting good prices was so easy, there wouldn't be any markets/any business...

What I have experienced many times is an order sitting for hours, I cancel and replace and its instantly filled at the same price. Not sure why, but "playing with orders" works many times.

 

 

 

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Does the Mark price (in IB and perhaps other platforms too) ever play a role in discerning where to set price limits? I can't work out where that value comes from in many instances, especially when the option has not traded for some time?  

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39 minutes ago, Jasper said:

Does the Mark price (in IB and perhaps other platforms too) ever play a role in discerning where to set price limits? I can't work out where that value comes from in many instances, especially when the option has not traded for some time?  

The mark is synonymous with mid as I refer to in the article. It's the midpoint between the bid/ask spread. So an option trading at $1.00 x $1.06 would have a midpoint of $1.03, which is what most brokers will "mark" the contract at on their platform for the purpose of P/L. It's essentially the hypothetical fair value, but as mentioned in the article we shouldn't expect to always get filled at this price.

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20 minutes ago, MSNFL said:

Very helpful. Quick question. I use Etrade. How does one route contracts to different exchanges?

 

Same question for Tradier.

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I'd have to defer to others for different brokerages, I'm personally only familiar with TD Ameritrade/Think Or Swim. 

1795063582_ScreenShot2021-04-08at2_49_46PM.thumb.png.e508a703e8d9a03e207cd38eeecb505b.png 

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Hi @Jesse - I believe TOS doesn't allow direct routing for multi leg options. In that case, for multi leg options like Calendars or Butterflies, do you process the contract orders individually to route them to different exchanges? 

Edited by Infineo

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On 4/10/2021 at 7:59 PM, Infineo said:

Hi @Jesse - I believe TOS doesn't allow direct routing for multi leg options. In that case, for multi leg options like Calendars or Butterflies, do you process the contract orders individually to route them to different exchanges? 

You can direct route on spreads/multi leg orders at TOS. There may just be fewer exchanges that the order can go to vs. a single leg. It will depend on the underlying.

 

2126782972_ScreenShot2021-04-12at9_13_21AM.thumb.png.957f91f6186d18e2c11fb2920524d859.png

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59 minutes ago, Jesse said:

You can direct route on spreads/multi leg orders at TOS. There may just be fewer exchanges that the order can go to vs. a single leg. It will depend on the underlying.

 

2126782972_ScreenShot2021-04-12at9_13_21AM.thumb.png.957f91f6186d18e2c11fb2920524d859.png

Got it .. Thanks!

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Hi @Jesse and thanks for posting an important topic. 

I would add that having access to a smoothed theoretical value is a very important for assessing whether the mid-market price is 'fair' or not. 

Below is an example:

For XLP, selling a 67.5 67.5 put spread at mid markets results in a debit, or paying to sell the put spread! Refer to the payoff diagram below, there is no way to be profitable as all points are red (loss).

The theoretical value of the put spread from ORATS smooth market values (SMV) is $0.39 - $0.23 = $0.16

a61ad35a9914ef0ccb01dac7f2711f5d.png
 

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I did add it under global, but it's not showing. I am trying to add it to Strategy builder and it's not there. Thank you

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 This is what I use in TWS. Do you use another window for options?

 

20210423_161440.jpg

Edited by BGG_

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4 hours ago, BGG_ said:

 This is what I use in TWS. Do you use another window for options?

 

20210423_161440.jpg

In TWS each widow has a gear icon(Configuration) in the top right corner. There you can configure columns.

For the option chains specifically you can also click gear icon, or you can right click on any column title and select "Configure Layout".

Screen Shot 2021-04-23 at 10.08.08 PM.png

There you can add Mid
Screen Shot 2021-04-23 at 10.11.02 PM.png

Hope this helps.

Edited by IgorK

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Thanks for the replies. I can add it on the main page " calls and puts" and wanted to do it under "strategy builder" as it is much easier once you add the calendars to your watchlist. Then with my mouse I just grab the instrument created and place it in the "strategy builder" window where it shows the individual options and prices bit no option to add "mid" price in the layout there. I guess the other way is to also add the underlying options individually in the watchlist.

Any advice on your TWS setup would be greatly appreciated. 

Never used the Classic, may have to give it a try. 

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How is the experience with the SMART Routing Algorithm from Interactive Brokers? Would you also try to route orders to different exchanges or is the SMART algorithm "good to go"?

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6 hours ago, christrades said:

How is the experience with the SMART Routing Algorithm from Interactive Brokers? Would you also try to route orders to different exchanges or is the SMART algorithm "good to go"?

 

I can't comment on that as I don't trade at IB (longtime TD Ameritrade/TOS user). IB is a great broker so you're likely getting excellent execution assuming you follow the other tips discussed in this article.  

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