Limit orders are the most widely used order type because it guarantees that you get into or out of a trade at the price you want. For 99% of the trading we do here, I use limit orders to make sure that I get the price I want. Using limit orders requires you to be more patient in your trading, but as position and income traders we don't need to be super fast getting into and out of day trades.
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In this video tutorial for limit orders when dealing with options. As always, we'll get right into it here and we're once again back on my Thinkorswim platform here and we're going to take a look at some limit orders.
I think it's better to look at these on a platform than to look at them with pictures. I've never been a fan of pictures of limit orders and market orders. Let's just say we're trading Apple options.
We’ve already typed in AAPL which is the ticker symbol for Apple and we have the option pricing table that’s already opened up. If we’re going to actually trade let’s say the February 2012 contracts, we’re going to open up that pricing and we’re going to go down and choose our option that we want to trade.
Let’s just make sure we’re dealing with the mark. You can see here that the… Let’s say we think Apple is going to go lower. You could think it’s going to go higher. It’s all basically the same premise.
But let’s just say we’re going to trade the put options on Apple. It’s currently trading at 376 and we want to trade the 375 put options for February. Right now, the bid is 25.70 and the ask is 25.90.
If we’re going to buy an option, we want to be right around 25.80 which is the mark or the average price between those two. You usually want to be dealing in the mark. If you actually buy or sell at the bid, you might be buying or selling too high or too low.
Let’s just say that we actually want to go in here and buy at the ask. If we click the ask price, you can see it brings up the 25.90, but we’re actually going to adjust that down to the 25.80 because we’d be buying it $.10 higher than we really want to.
Now we have our price of 25.80 which matches up with the 25.80 mark in the current market. Reviewing our order, we have a single option, we’re on the buy side of the trade, one quantity for Apple, AAPL February 2012 expiration, a 375 strike put option.
Here’s where the limit order pricing comes into play. You can see that my order type here, I have a lot of different order types that I can choose. I can choose market limit, stop limit, etcetera and we’ve gone over videos on all of these different orders.
But in this video, we’re talking about the limit order which is this one here. Basically what this is saying is that “I am not going to pay any more than 25.80 for this particular option.” I can adjust this down to let’s say 25.70.
What this will say to the market is that “I know that the Apple option 375 put is currently trading at 25.80, but I’m not going to pay any more than 25.70.” This order will go into the market and will be working all day and looking for a buy price of 25.70.
If Apple’s option gets down to that price, this price will execute if there’s another trader. But let’s just say that Apple’s option continues to go up in value, so it goes from 25.80 all the way up to 26.
Since this is a limit order and you’re limiting the price that you want to get into the security, then you’re actually not going to get filled at that price. It’s got to come back down and hit your limit price.
You could have this order working all the way down here at 24 for example and have it always, always working at 24. This option may or may never get hit and that’s the risk that you run with limit orders, is that you know your exact price, but you’re just not sure of an exact fill in the market.
If you were going in and let’s say you had an option and you wanted to get it out of it. Let’s say you own the 375 option and you bought it and you have a really good profit, so you want to sell this option. A limit order works the same way for sellers. It limits the price that you’re willing to sell at.
I just went in here and I clicked the bid price which is the price I’m going to sell at. The market is 25.80, but you can say to yourself, “I don’t want to sell this option unless it’s worth at least 26. The option is worth 25.80 right now.
You’re only going to sell at a limit price of 26 for the entire option. This option has to go up in value to 26 for you to be able to sell and the broker would execute that automatically if there’s another trader who’s willing to trade at that price as well.
The risk you run when you’re getting out of an option or selling an option is that the option price never runs up to that price point. You put a limit price in of 26, the market is currently trading at 25.80 and the option never gets to that price point and then you could actually have to adjust your limit price down whereas you would’ve gotten out of the option a lot sooner.
That’s the basics on limit orders. They’re fairly simple. As always, you can enter these orders for the market day or GTC which is good-till-cancelled. Most of the time, I enter my orders GTC because I know that I want to get into the position, it’s just a matter of time and if the option price doesn’t get hit, then I’ll come in here and I’ll adjust the limit price going forward.
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