Do not use a market order for options trading

Financial literacy

Many investors sabotage their retirement unnecessarily – and for my life, I can’t figure out why.

One thing I will never understand about the market is why there should even be an option to place market orders on daily trades. These orders put investors in more trouble than any other strategy when buying or selling stocks.

A market order allows you to buy a stock or option at the price it is trading at when your order is received. It might not hurt trading stocks with penny spreads if the market does not move quickly.

But for LEAPS (Long-Term Equity Anticipation Securities) options that trade with a huge spread, say at an offer of $ 1.20 and a ask of $ 1.80, you might be the unlucky investor to get 1 , $ 80 or more with a market order. Yet many investors still choose this over using a limit order or trying to buy in between.

A buy order at the market means you want to buy at all costs.

But is this really what you want to do?

When you sell, the same rules apply. If you say “sell to the market”, you say “take me out at all costs”.

On a slow day, it might not be that bad. The share price may not move much. But when the stock starts to move, you will most often regret this market order.

The wrong time for a market order

To take Beyond meat (Nasdaq: BYND), for example. Its stocks have shown that they can move $ 1 or $ 2 in milliseconds.

Do you really want to risk paying all price or sell for all the price?

If you’re considering using a market order, make sure it’s for a good reason.

For example, panic selling on bad news may be the only way out of a stock when it is falling like a rock. You’ll get a horrible price, but you’ll likely fare better than your neighbor.

Buying in a moment of euphoria after finding out something the market is about to figure out might also be worth it. A market order here will ensure you enter even if the price starts to move.

However, for options, market orders are a no-no most of the time. This is because the options market is less liquid than the stock market, so oversized movements don’t really get a close look.

Everyone, including market makers and regulators, knows that options have big spreads. And they know non-professionals will always pay. After all, this is how market makers make a lot of money!

When trading options, your first order should be less than halfway between the offer and the offer. If that doesn’t work, increase your price until you’re full.

The only time to use a market order with an option is when you have a tight spread and cannot be executed on a limit order. In this case, you need to take the extra step of knowing how many contracts are on offer (if you are selling) or on demand (if you are buying).

For example, if you sell five contracts and there are only three contracts on offer, you can guarantee that you will get robbed. The market maker can “deviate” for the balance, and you will get even less.

But if the supply is high, say 100 contracts, and you sell in the market, chances are you are filled with the supply or more. Then you can use a market order to try to get a better price if there is a good size gap.

Action plan: Desperate times call for desperate action, and it is the time of market orders. In most other situations, you’ll be better off using only limit orders.

About Karim Rahemtulla

With over 20 years of experience, Karim masters the subtle art of options trading. What we admire about him is his ability to make huge gains while minimizing the enormous amount of risk that often comes with options. Beyond his expertise in options trading, he is also the author of the bestselling book Where in the world should I invest? He publishes every week on smart speculation in his latest free email newsletter, Trade of the day.

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