If you’re a frequent reader of my blog, you’ve probably figured out that I’m a fan of contingent orders. I first introduced the benefits of using a contingent order over stop order in this post some time back.
This previous post was based on a single leg option position – but now TradeKing clients can also enter a contingent order for multi-leg option strategies. You just pre-set a target price for the underlying security or a specific option contract. If your target price is reached, we'll activate a market or limit order for any strategy you choose - including multi-leg option strategies like bull or bear spreads, butterflies, condors, covered calls and more. Nice, eh?
Contingent spread orders can come in handy in many situations, but in light of my recent series on rolling (read the posts on puts and calls here) I thought I’d walk through a rolling example. In the final post of that series I mentioned one rule-of-thumb for rolling: “If you’re going to roll, roll fast.” That is to say, the decision to roll or not to roll has everything to do with your forecast for the underlying stock from this point forward. If, for example, you’ve sold an option and it’s going in-the-money (ITM), if it gets really deep ITM the cost to buy back the short option will be steep. When rolling, your goal is to sell another option and generate enough - if not more than enough - cash from the new sale to pay for the buyback of your short option.
Contingent spread orders make this tricky process a little easier. The first step is to set up the roll in the spread order screen. Let’s use August and September options as an example. Say we’re short the Aug 50 call, and the stock is currently at 48. If it does hit 52 we have predetermined we’d like to roll the call up an out in time. In other words, the trade we plan to enter is to buy to close the Aug 50 call and sell to open the Sep 55 call. It looks like this:
BTC Aug 50 Call
STO Sep 55 Call
For a next credit of ??? to the account.
The next step is to select contingent order in the Advanced Order dropdown menu; a new entry box will appear. Click the picture to enlarge.
If the underlying stock’s (XYZ) last price is more than 52, we want to send our order to the market. Finally we’ll select “good until cancelled” (GTC) for the order duration. That part means the order will stay in the system until we decide to cancel the trade. Click on picture to enlarge.
Now for the tricky part: what is the net credit we hope to receive on the trade? There is no good way of knowing what the bid and ask would be for the “roll” when the stock hits 52. So some might enter this as a market order and just roll no matter what. That might be an especially attractive choice if you’re trading very liquid securities like the SPY or QQQQs.
But on a lower option volume stock you might just want to make an educated guess as to what the credit could be. So I would look at what the roll bid ask is for the Aug 45 and Sep 50 is at currently and make a guess from there. The logic here is that the Aug 45 is already in-the-money, and it will have a starting point for guessing a credit to enter the trade at. So let’s say we enter it with a $1 credit for the roll. Now if you do decide on a limit credit, I would check on the trade after it was sent and see if your guess is a viable limit. There is a risk here that, if it’s not viable, the stock could just blow though your limit, leaving you without a fill.
Guessing the credit is as much art as science, and I realize this isn’t perfect - but at least you have an order working for your roll. If you do go the market-order route the roll should fill at the next available market price.
Regards,
Brian (OG)
[image: dominos 3 by greg westfall on flickr]
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.
While implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or probability of reaching a specific price point there is no guarantee that this forecast will be correct.
Any strategies discussed or securities mentioned, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities.
