Options Trading Procedures
Every options trader needs to be familiar with the basic features of the market. So, we explore the action that takes place on the market floor and the ways in which traders away from the exchange can have their orders executed on the exchange. Essentially, there are three types of people on the exchange floor: traders, clerical personnel associated with the traders and exchange officials.
Types of traders
There are three different kinds of taders on the floor of the exchange: Market makers, floor brokers, and order book officials.
The market maker.
A trader who trades for his own account is a market maker.The typical market maker owns or leases a seat on the options exchange and trades for his or her own account to make a profit. Typically, a market maker will concentrate on the options of just a few stocks. Market makers follow different trading stratigies and switch freely from one strategy to another. Some market makers are scalpers who follow the psychology of the trading crowd and tries to anticipate the direction of the market in the next few minutes. Generally, the scalper holds a position for just a few minutes, trying to make a profit on moment ot moment fluctuations in the option’s price. By contrast, a position tader buys or sells options and holds a position for a longer period. This commitment typically rests on views about the underlying worth of the stock or movements in the economy.
The Floor Broker.
A trader who executes orders for another is a floor broker. Many options traders are located away from the trading floor. When an off-the -floor trader enters an order to buy or to sell an option, the floor broker has the job of executing the order. Floor brokers typically represent broerage firms. They work for a salary or receive commissions, and their job is to obtain the best price on an order while executing it rapidly.
The order book official.
The order book official is an employee of the exchange who makes certain kinds of option trades and keeps the book of orders awaiting execution at specified prices. The order book official is an employee of the exchange who can also trade. However, the official cannot trade for his or her own account. Instead, he or she primarily helps to faciliate the flow of orders. In essence, the order book official performs many of the functions of a speciallist on a stock exchange.
Exchange officials comprise the third group of floor participants. Besides the order book offical and assistants are exchange employees, there are other exchange employees on the floor, such as price reporting officials and surveillance officials. After every trade, price reporting officials enter the order into the exchange’s price reporting system. Then traders and other interested parties around the world will know the price and quantity of a particular option that just traded. The exchange also has personnel on the floor to monitor floor activity. The exchange has the responsibility of providing an honest marketplace, so it strives to maintain an orderly market and to ensure that brokers and market makers follow exchange rules.
Types of orders
Every options trade falls into one of four categories. It can be an order to (1) open a position with a purcahse; (2) open a position with a sale; (3) close a position with a purchase; or (4) close a position with a sale.
As in the stock market, there are numerous types of orders in the options market. The simplest order is a market order. A marekt order instructs the floor borker to transact at whatever price is currently available in the marketplace. The alternative to a market order is a limit order. In a limit order, the trader instructs the broker to fill the order only if certain conditions are net.
Order routing and execution
Suppose a professor decides that today is the day to buy an option on XYZ. He calls his local broker and places a market order to buy a call. The broker takes the order and makes sure he has recorded the order correctly. The broker then transmits the order to the brokerage firm’s representatives at the exchange. usually this is done over a computerized system operated by the brokerage firm.
The brokerage firm’s clerical staff on the floor of the exchange receives the order and gives it to a runner. The runner quickly moves to the trading area and finds the firm’s floor broker who deals in XYZ options. The floor borker executes the order by trading with another floor broker, a market maker, or an order book official. Then the floor broker recordes the price obtained and information about the opposite trader. The runner takes this information from the floor broker back to the clerical staff on the exchange floor. The brokerage firm clerks confirm the order to the broker, who tells the professor the result of the transaction. Normally, the entire process takes about two minutes and the professor can reasonably expect th receive confirmation of his order in the same phone call used to place the order.