Use Limit Orders on Options Trades

Use Limit Orders on Options Trades
by Ken Trester 04/21/08

I have a confession to make: I am cheap -- really cheap.

Now, I don't mean to say that I skimp on quality. I just like to get the best price possible, no matter what I am buying -- a car, an airline ticket, a hotel room -- and I especially like to save when I'm buying options. The cheaper, the better!

My favorite options to trade are those that are undervalued and, thus, underpriced. I'm looking for those calls and puts that are ready to blast off into profitability, both alongside and even ahead of their underlying stocks. And the cheaper we can get them from the outset, the more upside we can enjoy when the trades start to move in our favor.

I have no problem with being called "cheap" when it comes to getting into an option trade just before it takes off, because when I'm cashing out of a winning trade, I'm taking home more dough than the guy who paid a lot more to enter the same trade!

But what if you could pay even less for low-cost options trades?

Suppose you're interested in buying to open an option that has a "bid" price of $1 and an "ask" (or "offer") price of $1.30. To buy that option right now, you would need to pay $1.30, as that is the price that a seller is "asking" for.

But before you do that, take a minute or two to test the waters. If that $1.30 is the market price and you tell your broker to use a market order (i.e., to purchase the option immediately, no matter where it's trading) to buy that option, this is likely what you would pay.

Instead of a market order, take advantage of the fact that the options world truly is a marketplace -- one where you can possibly get a better price just by asking. How does that work? If you use a limit order (instead of a market order) when opening a position, you can tell your broker how much you are willing to pay to enter a trade.

For example, if you enter a limit price of $1.15, you can see whether the market-maker will bite. You will be surprised at how many times you will get your price (i.e., $1.15) instead of the ask price of $1.30.

If your order at $1.15 is not filled after a few minutes, you can modify your order and pay the ask price by entering a market order or limit order at the ask price (that is, you can tell your broker to pay no more than $1.30).