From the October 01, 2009 issue of Futures Magazine • Subscribe!

Getting your fill: Option spreads

Over the last decade or so, traders have witnessed an unprecedented advancement in trading technology and access to the markets. Traders now enjoy everything from streaming quotes showing accurate bid/ask spreads and market depth, to point-and-click trading with instant fills, and up-to-the-second account reconciliation and accounting.

The days of an active day-trader having to manually match buys and sells to see where he or she stands is a thing of the past. To those who weren’t born into this exciting new world, the current landscape is incredible: The things traders fantasized about in the 1980s and dreamed about in the 1990s are now not only a reality, but a necessity.

With the creation of electronic global access, traders now have multiple doors of entry to many of the markets. However, this seems to confuse many traders more than help them. To better understand how this new access is a benefit to a trader, consider this: Chicago Board of Trade Treasury bonds are one market with two doors to gain entry or exit, open outcry (pit session) or the Globex market (electronic access).

Regardless of the entry method, the market is the same. It’s just that the pit session “door” is accessible from 8:20 a.m. until 3 p.m. (Eastern), while the Globex “door” is open from 6:30 p.m. until 5 p.m. (Eastern). That’s 22-1/2 hours a day for Globex! It’s also worth mentioning that you can enter through one door and leave through the other. It doesn’t matter. It’s the same market. However, those who have used both markets will tell you that the Globex alternative offers faster fills with more transparency.


The only order-entry challenge for a modern-day futures trader is placing option spreads. While the equity options world has long been primarily an electronic market, options on futures are the last bastion for the futures trading floor. And while there has been progress electrifying simple options on futures, complex orders still require that personal touch. Many order-entry platforms, as well as the various electronic exchanges, do not accept multiple leg (beyond verticals) option spreads. In fact, many electronic exchanges don’t even accept market orders on single option trades, never mind what are considered complicated option chains, nor do they take limit (or better) orders on spreads.

The objective of a trader using option spreads is usually either outright premium collection, hoping to profit on the spreads erosion factor, or to collect premium to lower the cost of the primary long option. To reach this objective successfully, pricing control is essential. Not being able to work multi-leg spreads through an electronic platform on a limit order has left many spread traders perplexed. The inability to get trades filled at an acceptable price has caused many traders to abandon this type of trading.

All is not lost. Electronic option traders need to learn how to get around the limitations imposed by today’s technology to get the job done. Although option spread traders are limited in methods of order entry, the transparency of the true bid/ask spread of each leg gives the trader a little more control in the order entry process.

The reason for this is the absence of the floor’s one-leg-in rule, where on multiple-legged option spreads not all the legs had to be filled within the option’s trading range, as long as the entire spread was filled within the price limit placed. This rule was created to make it easier for the floor broker to fill these types of spreads, but it made the liquidation of the individual leg more difficult due to the possibility of a random fill when the order was originally filled.

In an open outcry environment, traders would place a multiple-legged spread all at once, taking the ask of the long option and subtracting the bids of the short options. The option floor broker would then try to fill the legs within the trader’s price limit. The price was usually derived from getting the bid-ask spreads on various suitable strike prices based upon the technical analysis at the time of the trade. Traders then would place the trade using a single price, leaving the execution of the trade in the floor broker’s able hands.

This strategy isn’t possible in an electronic environment due to the complexity of the math involved in the execution. Instead, we have to enter each leg of the trade individually. What this entails is a constant calculation of each of the legs, remembering that we pay the ask on the buys and sell at the bid on the shorts.

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