Market Orders are not for Option Traders
A recent note from a trader who is brand new to the options world asked whether it was advisable to enter market or limit orders when trading options. This is one of those easy-to-answer questions.
Years ago, stockbrokers encouraged customers to buy and sell ‘at the market’ to be certain that the customer’s order was filled. Why was that important to the broker? If the limit order went unfilled, then the broker earned no commission.
There is plenty of evidence to suggest that most brokers were more interested in their own income than that of their customers.
That system has changed and most of today's traders never speak with a broker (customer service does not account because that person is not a licensed broker) and enter our orders over the Internet. There is no one urging us to use market orders, and that is a good thing.
With no pressure to enter a market order, the question is: why you would want to do so? What is to be gained? A market order should be reserved for one specific situation.
That completes the list.
If you just discovered some news about a given stock and believe that you must buy it immediately, consider how foolish that is. It is far too late. Every professional trader on the planet has seen the news (and already bought or sold) before that news reaches you. If this news release provides useful information – don’t you want to verify the accuracy before making an investment?
Additional rationale
Do you require reasons not to enter a market order? How about this simple one: Bid/ask spreads are often wider than the true markets. In other words, if you enter a market order you will pay more (or sell for less) than if you entered a market order.
One reason bid/ask spreads are kept wide is to make extra money from the foolish investors who enter market orders. Translation: The NBBO (national best bid and offer) may indicate that the highest bid is $1.50 and that the lowest published offer is $1.80. If you enter a market order, you will get filled at one of those prices. However, the probability is very high that if you bid $1.75 (or possible $1.70) your order will be filled immediately. In other words, other people were willing to sell at $1.75 but they do not advertise it so that they have a chance to sell at $1.80.
When selling, the same thing is true. It is almost certain that when the market is as wide as $1.50 to $1.80, there is going to be at least one market maker who is willing to pay $1.55. Why? No one makes money by failing to make trades. Sure the market maker would prefer to pay $1.50, but by paying $1.55 that MM gets to make the trade at a favorable price.
If you must, here is how to buy at the market
If you absolutely positively must make a trade this instant – for reasons that are crucial to you and/or your financial survival – you can still use a limit order. Bid the current asking price. Or even a penny or two higher. (Or sell at the current bid, or a touch lower.) Today, with lightning fast electronic orders, it would be almost impossible for the market to move away from your bid so quickly. In the above example, bid $1.82 (or even as high as $1.85) when you cannot afford to miss the trade. But there is no need to enter a market order.
Use limit orders. Please. And if you still find that you prefer to use market orders for option trades, there is probably little chance that you will find success as a trader. However, there are two situations where you must not give in to that need.
You can do this. No trade is that important that it must be filled right this instant.
Never use market orders.
Years ago, stockbrokers encouraged customers to buy and sell ‘at the market’ to be certain that the customer’s order was filled. Why was that important to the broker? If the limit order went unfilled, then the broker earned no commission.
There is plenty of evidence to suggest that most brokers were more interested in their own income than that of their customers.
That system has changed and most of today's traders never speak with a broker (customer service does not account because that person is not a licensed broker) and enter our orders over the Internet. There is no one urging us to use market orders, and that is a good thing.
With no pressure to enter a market order, the question is: why you would want to do so? What is to be gained? A market order should be reserved for one specific situation.
If you do not get filled this instant, something dreadful will happen.
That completes the list.
If you just discovered some news about a given stock and believe that you must buy it immediately, consider how foolish that is. It is far too late. Every professional trader on the planet has seen the news (and already bought or sold) before that news reaches you. If this news release provides useful information – don’t you want to verify the accuracy before making an investment?
Additional rationale
Do you require reasons not to enter a market order? How about this simple one: Bid/ask spreads are often wider than the true markets. In other words, if you enter a market order you will pay more (or sell for less) than if you entered a market order.
One reason bid/ask spreads are kept wide is to make extra money from the foolish investors who enter market orders. Translation: The NBBO (national best bid and offer) may indicate that the highest bid is $1.50 and that the lowest published offer is $1.80. If you enter a market order, you will get filled at one of those prices. However, the probability is very high that if you bid $1.75 (or possible $1.70) your order will be filled immediately. In other words, other people were willing to sell at $1.75 but they do not advertise it so that they have a chance to sell at $1.80.
When selling, the same thing is true. It is almost certain that when the market is as wide as $1.50 to $1.80, there is going to be at least one market maker who is willing to pay $1.55. Why? No one makes money by failing to make trades. Sure the market maker would prefer to pay $1.50, but by paying $1.55 that MM gets to make the trade at a favorable price.
If you must, here is how to buy at the market
If you absolutely positively must make a trade this instant – for reasons that are crucial to you and/or your financial survival – you can still use a limit order. Bid the current asking price. Or even a penny or two higher. (Or sell at the current bid, or a touch lower.) Today, with lightning fast electronic orders, it would be almost impossible for the market to move away from your bid so quickly. In the above example, bid $1.82 (or even as high as $1.85) when you cannot afford to miss the trade. But there is no need to enter a market order.
Use limit orders. Please. And if you still find that you prefer to use market orders for option trades, there is probably little chance that you will find success as a trader. However, there are two situations where you must not give in to that need.
- Never use a market order at the market opening.
- Never use a market-on-close order.
You can do this. No trade is that important that it must be filled right this instant.
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