Order Execution

Most customer orders, which are market orders or executable limit orders, will be routed electronically to the trading post for automatic execution. The electronic system bypasses the firm’s commission house broker, the order is executed automatically, and an execution report is sent back to the brokerage firm. The more complex orders will be handled by the firm’s commission house broker. A member firm may not execute an order for a listed option off the floor of the exchange unless it has tired to execute the order on the floor and a better price is available in another trading venue.

Types of Orders

Investors can enter various types of orders to buy or sell options. Some orders guarantee that the investor’s order will be executed immediately. Other types of orders may state a specific price or condition under which the investor wants their order to be executed. All orders are considered “day” orders unless otherwise specified. All day orders will be canceled at the end of the trading day if they are not executed. An investor may also specify that their order remain active until canceled. This type of order is known as “Good Til Cancel” or “GTC”.

Market Orders

A market order will guarantee that the investor’s order is executed as soon as the order is presented to the market. A market order to either buy or sell guarantees the execution but not the price at which the order will be executed. When a market order is presented for execution, the market for the option may be very different from the market that was displayed when the order was entered. As a result, the investor does not know the exact price that their order will be executed at.

Buy Limit Orders

A buy limit order sets the maximum price that the investor will pay for the option. The order may never be executed at a price higher than the investor’s limit price. While a buy limit order guarantees that the investor will not pay over a certain price, it does not guarantee them an execution. If the option continues to trade higher away from the investor’s limit price, the investor will not purchase the option and may miss a chance to realize a profit.

Sell Limit Orders

A sell limit order sets the minimum price that the investor will accept for the option. The order may never be executed at a price lower than the investor’s limit price. While a sell limit order guarantees that the investor will not receive less than a certain price, it does not guarantee them an execution. If the option continues to trade lower away from the investor’s limit price, the investor will not sell the option and may miss a chance to realize a profit or may realize a loss as a result.

FOCUS POINT!

It’s important to remember that even if an investor sees options trading at their limit

price, it does not mean that their order was executed because there could have been orders ahead of them at that limit price.

Stop Orders / Stop Loss Orders

A stop order or stop loss order can be used by investors to limit or guard against a loss, or to protect a profit. A stop order will be placed away from the market in case the option starts to move against the investor. A stop order is not a “live” order; it has to be elected. A stop order is elected and becomes a live order when the option trades at or through the stop price. The stop price is also known as the trigger price. Once the option has traded at or though the stop price the order becomes a market order to either buy or sell the option depending on the type of order that was placed.

Buy Stop Orders

A buy stop order is placed above the market and is used to protect against a loss or to protect a profit on a short sale of an option. A buy stop order could also be used by a technical analyst to get long an option.

Sell Stop Orders

A sell stop order is placed below the market and is used to protect against a loss or to protect a profit on the purchase of an option. A sell stop order could also be used by a technical analyst to get short an option.

Stop Limit Orders

An investor would enter a stop limit order for the same reasons they would enter a stop order. The only difference is that once the order has been elected, the order becomes a limit order instead of a market order. The same risks that apply to traditional limit orders apply to stop limit orders. If the option continues to trade away from the investor’s limit, they could give back all of their profits or suffer large losses.

 

TAXATION OF OPTIONS

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