Trading Mechanics. Putting On a Position

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Edwin Richardson
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1 Trading Mechanics Putting On a Position

2 Trading Mechanics Options involve risks and are not suitable for everyone. Prior to buying or selling options, an investor must receive a copy of Characteristics and Risks of Standardized Options. Copies may be obtained by contacting your broker or The Options Industry Council at One North Wacker Drive, Suite 500, Chicago, IL In order to simplify the computations, commissions, fees, margin interest and taxes have not been included in the examples used in these materials. These costs will impact the outcome of all stock and options transactions and must be considered prior to entering into any transactions. Investors should consult their tax advisor about any potential tax consequences. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation or solicitation to buy or sell securities. Past performance is not a guarantee of future results.

3 Presentation Outline What You Will Learn Opening option accounts Understanding cash requirements Before you trade Entering orders Understanding the option marketplace Types of option orders Once position established stay informed

4 Trading Mechanics Opening Option Accounts

5 Opening an Option Account Obtain Option Disclosure Document ( O.D.D. ) Option agreement option trading authorization for new and existing accounts brokerage firm-specific forms will vary by firm Approval process what you ll disclose net worth & investment knowledge previous option activity and history investment goals & objectives appropriate strategy and qualifications based on above

6 Trading Mechanics Understanding Cash Requirements

7 Understand Cash Requirements Commissions vary by firm pay flat fee and/or per contract charge ask for commission schedule understand commission effects of returns Margin requirements firm specific - SMA minimum account balance varies by firm long options requires full payment more risk, more margin may be significant account insufficient firm can close out

8 Understand Cash Requirements Tax ramifications understand completely booklet: Taxes & Investing obtain and read from OIC Brokerage firm s options agreement varies by firm read and understand!

9 Understand Cash Requirements Exercise & Assignment - Ramifications Long options investor in control of exercise exercise at any time before expiration (American Style) understand cash requirements be prepared Long calls exercise buy underlying shares pay cash for each share possibly on margin Long puts exercise sell underlying shares receive cash if shares owned sell if short position large margin possible & must qualify

10 Understand Cash Requirements Exercise & Assignment - Ramifications Short options investor not control assignment equity - assignment possible any time before expiration understand cash requirements be prepared Short calls assigned sell underlying shares receive cash if shares owned sell if short position large margin possible & must qualify understand risks of being short the underlying shares Short puts assigned buy underlying shares pay cash for each share possibly on margin

11 Trading Mechanics Before You Trade

12 Before You Trade Option Quotes & Information Basic option quote types of information level 1 bid/ask, quote size, last trade, volume, high/low generally provided free & delayed by brokerage firm Higher level quote services more information exchange-specific quotes & sizes time & sales - historic trading information Greeks, implied/historic volatility, position analysis Option chains look for all series in class in one picture filterable sometimes possible to place orders from option chain easier access to more information

13 Before You Trade Option Quotes & Information Option pricing calculator sometimes included with quote service access useful for scenario analysis Options Investigator software Quotes - know what you re looking at delayed? real-time but not dynamic requires refresh? up-to-minute streaming data most sophisticated? info consolidated or exchange specific? Trade confirmations know brokerage firm s method & timing of delivery

14 Before You Trade Plan in Advance Have an outlook underlying stock direction & timeframe Have an investment goal speculation for profit? earn income on assets owned? buy or sell stock at predetermined price? limit losses, lock profits or both? Set expectations accordingly prepare for positive & negative scenarios reduce surprises stick to your original plan be rational not emotional

15 Before You Trade Plan in Advance Think about available strategies consider outlook and investment objective weigh your tolerance for risk vs. potential reward understand consequences of exercise/assignment Select & be committed to a strategy be realistic don t just hope Importance of discipline always account for the unexpected don t let emotion whip-saw you

16 Before You Trade Plan in Advance Have an exit strategy as important as establishing position plan when to get out upside and downside consider rolling & when you might do it avoid being forced to take action Seek help/advice if needed brokerage firm and/or investment advisor OPTIONS Worth repeating be informed, know expectations, have a plan

17 Trading Mechanics Entering Orders

18 Entering Orders Methods Your Choice Enter through broker (on phone) get help and/or advice usually at higher commission rate slower entry give broker your objectives and goals for each trade Enter electronically (via internet) usually lower commission quicker entry, order status & confirmation double check click enter = your trade if filled frantic markets site busy firm s contingency plan?

19 Entering Orders Information Needed Avoid delays information always needed buy and/or sell? # contracts? underlying stock (option symbol)? call and/or put, strike price & expiration (option code)? premium amount? open or close? direct order to exchange of choice if capable Are you qualified? know your account types of trades authorized Know & have the cash requirement?

20 Trading Mechanics Understanding Option Marketplace

21 Understanding the Marketplace Electronic vs. Open-Outcry Both may be available Electronic market environment bid/ask prices updated automatically transparent market size disseminated trades executed or orders booked automatically order status & confirmation can be instantaneous not available for all order types consider when speed is most important

22 Understanding the Marketplace Electronic vs. Open-Outcry Open-outcry market environment bid/ask prices & size updated/disseminated trades executed auction-style generally available for all order types consider if order complex not eligible for electronic Some marketplaces mixed environment option marketplace strives for best-price execution

23 Understanding the Marketplace Who Makes the Markets? Bid/ask prices made by market participants option professionals individual retail customers large institutions (pension funds, portfolio managers) Disseminated markets all orders and professional bid/ask considered current best bid and best ask disseminated result current consensus of market participants supply and demand-market forces in effect

24 Understanding the Marketplace Who Makes the Markets? Market professionals exchange members or their representatives obligations to disseminate bid/ask prices obligations to quote certain market size provide liquidity to market trade with public customers when orders don t exist Exchanges don t make markets just disseminate best prices of all market participants

25 Trading Mechanics Types of Option Orders

26 Types of Option Orders How They Relate to Your Order Execution Market orders price not specified order executed at best prices available entire order filled upon arrival at exchange multiple and/or unexpected prices possible emphasis on execution (now) rather than price exercise caution in a fast or volatile market or security Consider use? timing is very important to open/close position market is moving, especially against you

27 Types of Option Orders How They Relate to Your Order Execution Limit orders price specified on order order executed when price available or not at all entire order may or may not be filled better price(s) possible emphasis on price (specified) rather than execution Consider use? price is very important to open/close position market is moving in your favor or relatively stable avoid chasing the market market faster than you have a purpose behind your price not arbitrary!

28 Types of Option Orders How They Relate to Your Order Execution Day orders good only on day entered unless cancelled end of day unfilled portion automatically cancelled GTC orders - Good til Cancelled remain in effect until order filled order cancelled, or option(s) on order expire if used, don t forget about it All orders considered day order unless specified GTC

29 Types of Option Orders How They Relate to Your Order Execution Market not held orders executing broker has complete discretion as to when, at what price, if order executed Limit not held orders executing broker has complete discretion as to when or if order executed but not worse than limit Discretionary orders gives executing broker discretionary price amount e.g., buy 50 XYZ June 60 $3.50 w/ $0.10 Both allow broker to use judgment executing broker cannot be held to a fill

30 Types of Option Orders How They Relate to Your Order Execution Among other types of orders stock contingency & stop orders IOC immediate or cancel FOK fill or kill AON all or none Use of above? may not be eligible for automatic execution can slow order execution bid or offer may not be disseminated overuse generally not recommended

31 Types of Option Orders Spreads To Leg or Not To Leg? Spread = one or more legs enter as one spread order, or investor enters each side separately called legging Spread order simultaneous transactions position established at net debit/credit desired Legging risk of exposure to only one leg executed recommended to leg into long side first may incur higher commission costs

32 Trading Mechanics Once Position Established

33 Once Position Established Monitoring Keep an eye on the market be aware of market trends be aware of price of underlying stock via electronic and/or print media or your broker Keep an eye on your position check confirmations via broker call-back, , mail check current quotes routinely view account statements paper and online Keep informed news on underlying splits, distributions, spin-offs, take-over, etc. changing dividend dates and amounts

34 Once Position Established Monitoring Position prices what to watch for? effects of change in underlying price effects of time decay changing implied volatility Dividends don t let assignment be a surprise don t miss an exercise if it makes sense Before expiration take profits earlier than expected realize partial losses perhaps close profitable position not risk assignment

35 Once Position Established Your Brokerage Statement Check for purchase/sale price accuracy Daily account value? option values mark-to-market at end of each day Mark-to-market values? last sale if within closing bid-ask spread bid if last sale lower offer if last sale higher Accurate P&L picture? not always an accurate picture of intra-day prices determines margin requirements none-the-less

36 Once Position Established Where s the Exit? Close out at expiration or before liquidate all option and/or related stock positions realize profit or loss Exercise or accept assignment - understand cash requirements for purchase/sale of underlying margin requirements Let out-of-the-money options expire worthless Roll? timing which month & strike

37 Final Words Your plan make a good one and stick to it Your cash margin to establish position requirements after possible exercise/assignment Your information get the best quotes you can afford Your order weigh importance of timing vs. price order type be prudent

38 Final Words Your risk assess in advance monitor all along make sure you can sleep at night Your exit as important as your entrance Take Advantage OPTIONS

39 Trading Mechanics OPTIONS

Butterflies, Condors and Risk Limiting Strategies. The Options Industry Council

Butterflies, Condors and Risk Limiting Strategies December 17, 2013 Joe Burgoyne, OIC www.optionseducation.org 2 The Options Industry Council Options involve risks and are not suitable for everyone. Prior