as prices ﬂuctuate. In this way, special-ists are brokers to the ﬂoor brokers and receive a commission for everytransaction they carry out. Groups of specialists trading similar marketsare located near one another. These areas are referred to as trading pits.
Once your order has been ﬁlled, the ﬂoor trader contacts your broker,who in turn contacts you to conﬁrm that your order has been placed. Theamazing part of this process is that a market order—one that is to be exe-cuted immediately—can take only seconds to complete. Today, electronicexchanges like the International Securities Exchange handle a large num-ber  of  options  orders  and  offer  an  electronic  platform  to  match  optionbuyers and sellers.
Your broker, as your intermediary, is paid a commission for his or herefforts. Each completed trade costs $10 on the low end and $100 or moreon the high end. Stock commissions may also be based on a percentagevalue of the securities bought or sold. Remember, your broker should bein  the  business  of  looking  after  your  interests,  not  generating  commis-sions for the broker’s own pockets. Since your chief concern as a tradershould be to get the transactions executed as you desire and at the bestprice possible, choosing the right broker is essential to your success.Let’s review the stock market order process. The seven steps are:
1. You call your broker.2. The broker writes your order.3. Broker transmits your order to an exchange.
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4. Floor  broker  tries  to  immediately  ﬁll  your  order  or  takes  it  to  a 
specialist.
5. A specialist matches your order.
• If your order is placed as a market order, you get an (almost) imme-
diate ﬁll.
• If placed as a limit order, you have to wait until you get the price
you want.
6. Conﬁrmation is sent back to the broker.7. Broker contacts you to conﬁrm that your order has been executed.
This is the process for most transactions. In addition to the special-ists,  there  are  also  market  makers  who  are  there  to  create  liquidity  andnarrow  the  spread.  Market  makers  trade  for  themselves  or  for  a  ﬁrm.Once an order “hits the ﬂoor,” the market makers can participate with theother players on a competitive basis.
Stock orders are handled in a similar manner. For example, ordersfor  a  stock  trading  on  the  New  York  Stock  Exchange  or  the  AmericanStock Exchange are routed to the ﬂoor electronically or to a ﬂoor brokerby phone.
In  contrast,  Nasdaq—also  referred  to  as  the  over-the-counter  (OTC)market—is  an  electronic  computerized  matching  system  that  lists  morethan  5,000  companies,  including  a  large  number  of  high-tech  ﬁrms.  Bro-kers  can  trade  directly  from  their  ofﬁces  using  telephones  and  continu-ously revised computerized prices. Since they completely bypass the ﬂoortraders, they get to keep more of their commissions. There are no special-ists,  either—but  there  are  market  makers.  Their  role  is  to  bid  and  offercertain  shares  they  specialize  in,  thereby  creating  liquidity.  They  maketheir money on the spread—the difference between the bid price and theoffer price—as well as on longer-term plays. This difference may be only$0.25 or less. However, when you trade a large number of shares this addsup very quickly.
FUTURES (COMMODITY) ORDERS
Futures contracts are traded at commodity exchanges. The exchanges aredivided  into  trading  pits  that  are  sometimes  subdivided  into  sections  ofsmaller commodities. Individual trades are recorded on trading cards thatare turned in to the pit recorder, who time-stamps and keys the transac-tion into a computer. Some exchanges prefer the use of handheld comput-ers that instantly record the transactions.
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Orders  are  ﬁlled  using  an  open-outcry  system  in  which  the  buyers(who make bids) and the sellers (who make offers, otherwise known asthe ask) come together to execute trades. For example, in the gold mar-ket, if gold is trading at $300 per ounce, you may get a price of $299.50 to$300.50. This means that you would be buying the gold futures contract at$300.50 and you would be selling at $299.50. You may ask, “Why can’t I buyfor the lower price and sell for the higher price?” You can try, but the tradewill probably not be executed. The ﬂoor traders make their living off thisspread. They won’t want to give it up to you.
Let’s review the futures market order process. The six steps are:
1. Call  your  commodity  broker  (or  call  direct  to  the  trading  ﬂoor  for
large accounts).
2. The broker writes an order ticket or sends your order via computer or
calls the trading ﬂoor.
3. Floor broker will bid or offer.4. When your order is matched, the ﬁll is signaled to the desk.5. The desk calls your broker.6. Broker contacts you to conﬁrm trade execution.
Floor traders primarily make their money on the bid/ask spread. Theyare the ones who spend (in many cases) thousands of dollars each monthfor  the  privilege  of  being  on  the  ﬂoor  of  the  exchange  (or  hundreds  ofthousands  to  buy  a  seat).  They  can  either  lease  the  seats—gaining  theright to trade as an exchange member—or purchase the seats. In addition,they spend each and every day creating liquidity for the investor who isnot  trading  on  the  exchange  ﬂoor.  For  this  they  want  something  in  re-turn—the right to make money on the spread. The money to be made onthe spread comes from the difference between the bid and offer price. Inthe gold example, the reward is $1.00 ($300.50 – $299.50 = $1.00).
In addition, being right where the action is allows them to see the or-der  ﬂow.  Order  ﬂow  is  the  buying  and  selling  happening  around  them.They can spot when large traders are trading. This does give them an ad-vantage, but there are negatives. These include the following ﬁve aspects:
1. High monthly expenses.2. The need to always be in the market to cover costs.3. Sometimes getting caught up in emotion, not fact.4. Missed opportunities in other markets.5. Very physically and mentally demanding work.
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You probably have watched scenes of the trading pits on television orin movies. You see lots of people yelling and screaming. Is this the way itreally  is?  Yes,  when  there  is  action  in  the  market,  it  can  be  extremelyvolatile. If it is slow, people will read newspapers or just stay away. I dosuggest that you visit a commodity exchange if you get the chance. It isvery exciting and enlightening to experience what really goes on there.
Commodity  exchanges  have  to  provide  safeguards  for  the  publictrader. For every buyer there is a matching seller. Clearing ﬁrms—wherethe  funds  are  held—must  guarantee  that  each  person  trading  throughthem has the available funds to meet that trader’s ﬁnancial obligations, orthey  are  responsible  for  the  integrity  of  the  transaction.  This  system  ofchecks  and  balances  has  never  failed,  no  matter  how  crazy  the  marketshave become. Public investors can feel secure that they will not lose theirmoney due to the system failing.
PLACING AN ORDER
One of the most stressful functions of the new trader is actually to placethat ﬁrst trade. Picking up the phone or turning to the broker’s web site is,without  a  doubt,  a  time  of  considerable  angst.  After  all,  you  are  tryingsomething totally new. There is seemingly an endless number of choices,you are on your own, and, if you mess it up, it could conceivably cost youa lot of money—your money.
As  you  gain  experience,  you  will  settle  into  a  style  of  order  placingthat works for you and your broker, often forgetting that there are manyother  ways  that  might  possibly  solve  a  particular  problem.  This  sectioncovers the basics of how to place a trade, as well as some of the availableoptions that even the more experienced trader may have forgotten.
To place a trade, you need to communicate several speciﬁcs to yourbroker. The following list is designed to introduce you to these speciﬁcs,although in no particular order. This list can be applied to a single assettrade (stock, call, or put), but will work just as well for any of the Optio-netics-style combination (or hedge) trades. You will need to provide yourbroker with seven items of information:
1. Whether you want to buy (go long) or sell (go short) the security.2. The underlying stock (and possibly ticker symbol).3. The actual investment vehicle (stock, call, or put).4. For  an  option,  the  particular  month  and  strike  (and  possibly  the 
appropriate symbol).
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5. The number of shares or contracts.6. The type of trade (market, limit—and if so, what limit).7. Whether  you  are  “opening”  a  position  (initially  setting  up  the  posi-tion—long or short) or you are “closing” a position (selling an existinglong position or buying back an existing short position).
Some  brokers  and  most  web  sites  require  you  to  provide  the  exactticker symbol for your transaction. Other brokers will accept an order us-ing a plain English description of your transaction. Personally, I much pre-fer to give the plain English description, as then I am exactly sure of whatI am saying. Using the coded description (which you can search for on Op-tionetics.com)  is  just  too  easy  to  mess  up,  especially  for  a  beginningtrader  or  a  semiactive  trader  (one  who  “remembers”  the  code  from  lastweek or month). For instance, “AEQFI” and “AEQRI” appear to be almostidentical (at least with my handwriting!) and in fact are both options forAdobe Systems, ADBE. However, the “FI” is the descriptor for the June 45call,  while  the  “RI”  is  the  descriptor  for  the  June  45  put—both  ﬁne  op-tions,  but  hardly  interchangeable.  If  you  are  using  a  broker  that  cannotlook  up  the  symbols  (or  remember  them—they,  after  all,  do  this  many,many times per day), then be very careful that you in fact have the correctsymbol—it is your money that is on the line.
ELECTRONIC ORDER ROUTING SYSTEMS
In a relative sense, electronic communication networks (ECNs) are fairlynew. Changes in the 1990s made it possible for the small investor to getaccess to Level II data and compete with market makers through the useof ECNs. Level II quotes are one of three levels of the National Associa-tion of Securities Dealers Automated Quotations System (Nasdaq). Level Iquotes provide basic information such as the best bids and asks for Nasdaq-listed stocks. Level II data provides investors with more detailed quotes andinformation, including access to current bids and offers for all market mak-ers in a given Nasdaq-listed stock. Level III is the most advanced level and isused by market makers to enter their own quotes to the system. In order toutilize ECNs you need to use a broker who provides direct access to them.Most traditional online brokerages offer Level I quotes; only direct-accessbrokers provide Level II quotes.
ECNs  are  little  exchanges  themselves.  There  are  many  competingbids and offers from every single stock on each ECN. This depends a loton the interest in the stock you are following. For example, you might ﬁndlittle interest from ECNs in particular stocks and sometimes ﬁnd no inter-
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est at all for certain issues. By default, you will ﬁnd only the best bid andask from every ECN displayed in the Level II window.
Generally  each  ECN  is  able  to  communicate  only  within  the  sameECN. There are some “intelligent” ECNs, though, that take all other ECNsinto account. You are, however, able to display your own bids and offersthrough ECNs.
The major advantage of these networks is that your orders are sent di-rectly to the market, with no intermediary involved. They are kept in anelectronic environment. For example, assume you are attempting to buy600 shares of Cisco on an ECN and someone is willing to sell 600 shares ormore for $17. If you enter an order for $17, your order gets executed im-mediately since there is a matching sell order. If the seller would be will-ing  to  sell  only  300  shares,  then  you  would  get  executed  on  only  300shares. Also, since ECN orders are kept in an electronic environment theycan be immediately changed or canceled at any time.
The electronic Island network is the most popular order route amongday traders. It is very inexpensive and amazingly fast and offers tremen-dous liquidity. Some of the major rules applying to the Island network arethat  you  can  place  your  own  bids  and  offers,  there  is  no  limit  to  theamount of shares you can trade, and you can place only limit orders. Also,Island allows you to enter price limits with less than one-cent increments.Some of the bigger stocks can be traded on the network as well as Island,accounting for a large percentage of the total trades made on Nasdaq.
Archipelago is an intelligent order routing system. It has its own orderbook but is also able to communicate with other market participants. Arch-ipelago is a very useful system for day traders. Whenever there are ECNsinside of your price limit, Archipelago is generally a very good choice. Ifthere is a better price coming into the market, Archipelago tries to targetthat price. The network can only accept round lots for smart order rout-ing, and if you get a partial ﬁll it will keep resending your order until it iscompletely ﬁlled or you become the bid or ask yourself.
The  small  order  execution  system  (SOES)  was  developed  in  the1980s and was made mandatory after the 1987 stock market crash. Dur-ing the crash, market makers were ignoring their posted prices and there-fore  clients  weren’t  able  to  execute  their  orders.  This  system  made  itmandatory  for  market  makers  to  execute  orders  at  the  market  maker’sdisplayed price. It is for trading with the market makers only and cannotexecute to ECNs.
The small order execution system used to have many limitations to it,such as maximum number of shares that one could execute, as well as atime restriction for executing orders on the same stock. The biggest prob-lem  with  it  was  that  a  market  maker  was  required  to  execute  only  oneSOES order every 15 seconds.
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However, with the introduction of the new super SOES system theserules have changed signiﬁcantly. Market makers are now required to exe-cute  every  order  they  receive  up  to  the  size  they  are  displaying,  unlessthey  decide  to  change  their  offer.  You  can  now  execute  up  to  999.999shares via the new SOES.
Since market makers now have to execute every SOES order they re-ceive it has made SOES executions much faster and it has become a veryinteresting route for day traders again. You cannot display your own bidsand offers through SOES, and the old SOES system still exists for small-cap stocks.
The  other  ordering  system  worthy  of  a  mention  is  the  Selectnet  sys-tem, also known as SNET. SNET was developed by market makers in orderto execute their trades electronically and to avoid the verbal communica-tion  process  via  telephone.  Today  Selectnet  is  available  to  direct-accesstraders as well. Using an SNET preference order you can send your orderto every market participant available on the Nasdaq.
As  you  evaluate  any  of  these  systems  for  your  own  trading,  just  re-member  order  entry  rules  change  quite  frequently.  Make  sure  to  studyyour broker’s manual very carefully before making any trades.
ORDER MECHANICS
When you call your broker to place an order, it is a good idea to have all ofthe important information written down in front of you. What factors areimportant to this process? You have to know the quantity, the month, andthe  commodity.  If  there  are  options,  you  have  to  know  the  strike  price,whether you want calls or puts, and if there is a price. A ﬁll refers to theprice at which an order is executed. Let’s review the important items thatneed to be speciﬁed depending on the type of order you are placing.
1. Order type. The kind of order you wish to place. For example, a delta
neutral spread order.
2. Exchange. Sometimes you will choose the exchange where the orderis to be placed (for futures and options). Often, however, you will sim-ply choose “best,” which instructs the broker to send the order to theexchange showing the best price. The default in most cases is “best.”
3. Quantity. Number of contracts.4. Buy/sell. Puts or calls (also include the strike price and expiration).5. Contract. Name of the contract (e.g., T-bond futures).6. Month. Expiration month of the contract.7. Price. Instructions regarding price execution.
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Once you’ve decided to place a trade, you have to choose the type of orderto place. There are two basic order types: market orders and limit orders.Market orders are generally not the preferred way to trade when youare trading options. By placing a market order, you are assured of gettingthe trade executed immediately, but at whatever price the ﬂoor chooses tocharge you! You are, in effect, handing them a blank check. In reality, ifyou  are  trading  a  stock  or  option  with  much  activity,  the  price  that  thebroker gives you on the phone and the price the stock is trading at by thetime the order reaches the ﬂoor (a few seconds or minutes later) will notbe much different. However, thinly traded stocks and options may ﬁnd afairly large swing. Also, if your broker happened to give you a bad quoteor you didn’t hear it correctly and you place a market order expecting asimilar price, you may be quite disappointed. You would choose a marketorder  only  if  you  absolutely,  positively  had  to  have  the  trade  consum-mated right now, no matter what. Therefore, under most circumstances,the limit order is the preferred way to trade.
Limit  orders  come  in  many  forms,  but  the  basic  concept  is  that  youwant the trade ﬁlled only if it meets your requirements (primarily a pricethat  you  have  set).  This  protects  you  in  several  ways,  not  the  least  beingthat it protects you from the ﬂoor traders (manipulating the prices just asyour trade reaches the ﬂoor) and from yourself (making an error in calcula-tion, reading, hearing, or whatever). In a limit order, you will typically givethe broker a price for the trade. If it is a debit trade (you are paying moneyout of your account) that price is the maximum price that you pay, and if thetrade  is  a  credit  trade  (you  are  receiving  money  into  your  account),  thatprice is the minimum amount you will accept. Note: If the stock is movingrapidly, you can always set a limit outside the bid-ask spread.
For instance, if the stock is moving up and you want to be sure to buyit,  you  can  set  a  buy  price  of  $55,  even  if  the  bid-ask  quote  is  $49–$50.Your broker should be able to get the stock (or option) even if it is mov-ing, but you are protected from ﬁnding that the price is $60 or $70 by thetime  your  order  is  ﬁlled.  If  the  stock  price  does  jump  up  to  $70  by  thetime your order hits the ﬂoor, you, of course, will not be ﬁlled. But thennot getting ﬁlled is probably a good thing, especially if it was trading at$50 only moments before.
From that basic setup, there are a number of additional choices thatcan be made. The ﬁrst set of choices revolves around the duration of yourlimit order. There are basically three choices at this time:
1. Fill or kill. The broker is instructed to ﬁll the order immediately, or
kill (cancel) the order.
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2. Day order. This tells the broker to put the order in for the day; if it isnot ﬁlled by the close of the market today, then cancel the order. Thisis by far the most common type of limit order for two reasons. First, ifyou  don’t  otherwise  specify,  the  broker  will  automatically  place  theorder as a day order. Second, it protects you from forgetting that youhave  the  order  placed  with  the  broker,  and  being  surprised  some-where  down  the  road  when  you  get  a  ﬁll  notice  on  that  trade  youplaced weeks or months before. There is nothing stopping you fromplacing  a  series  of  day  orders,  if  the  original  order  was  not  ﬁlled.  Ifyou  forget  to  replace  the  order  and  circumstances  change  dramati-cally in your security, you will not be adversely surprised.
3. Good till cancelled (GTC). When you place such an order, your bro-ker will simply put it into the system and forget about it until yourcriteria are met. At that time, the order will be ﬁlled. Most brokersdo have a limit on GTC orders, and will automatically cancel themafter some period of time—two months, six months, and so on. Youshould inquire of your broker as to what their standards are. For in-stance,  one  of  the  brokerage  houses  I  use  will  accept  day  ordersonly for spread trades. However, my particular broker will automat-ically replace a spread order each morning if I have entered it as aGTC order. (I’ve been told this has something to do with their com-puter systems!)
Beyond the basic formats, there are numerous specialized order for-mats that could be useful for the trader in given circumstances. The fol-lowing list details a few of these formats, and the reasons for using them:
1. At-the-opening order. If you want to make sure that you buy or sella stock or option at the beginning of the day, you would place an at-the-opening order. Whatever price is set at the opening is the priceat which your order will be ﬁlled. Typically, you would place this or-der  if  you  were  expecting  a  large  move  in  the  stock  based  onovernight news.
2. Buy on close. If you want to buy the security for the closing price ofthe  day,  you  would  place  a  buy  on  close  order.  This  is  often  used  ifyou  are  short  a  put  or  call  on  expiration  day,  there  is  a  lot  of  timevalue still remaining in the option, and you don’t want to either pur-chase or deliver the actual stock. By placing a buy on close order, youwill  suck  out  the  entire  premium,  and  avoid  being  assigned  on  yourshort option position.
2. Buy on opening. The buy side of the at-the-opening order.
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3. Cancel  former  order. If  you  have  previously  placed  a  limit  order,  ithasn’t yet been ﬁlled, and you now want to cancel it, you would place acancel former order.
4. Exercise. If you are long an option and you either want the stock (ifyou are long the call) or you want to sell stock you own (if you arelong the put), you would exercise your option. You would choose toexercise the option as opposed to either buying the stock and sellingthe  call  or  selling  the  stock  and  selling  the  put  if  there  was  no  timevalue in the option (typically if the option is deep in-the-money). Youwill then get the strike price of the option (buying or selling) no mat-ter where the stock is presently trading, and with no slippage for thespread  between  the  bid  and  ask  prices.  The  exercise  of  the  optiontakes place after the market has closed for the day—it doesn’t happenimmediately.
5. Market-if-touched (MIT). This is an order that automatically becomesa market order if the speciﬁed price is reached. This is frequently doneas a form of protection for falling prices if you are long the stock or call,or rising prices if you are short the stock or long a put. Although it willnot absolutely protect you (the market price could slam down throughyour price and keep on going before it can be executed, or conversely itcould touch the price and then rebound, but still force you out of thattrade), it can be useful in some instances. This order can be used eitherto close out an existing long or short position or to create a new posi-tion (if you only want to buy XYZ Corporation if the price dips to $X).6. Buy stop order. Set a price (usually lower) than the current price, andif the market price falls to that speciﬁed price, the order becomes amarket buy order. This is the same as the market-if-touched order, butspeciﬁcally to repurchase a short position.
7. Sell on opening. The sell side of the at-the-opening order.8. Sell stop order. Set a price lower (as protection) or higher (to capturea proﬁt) than the current price, and if the market price reaches thatprice, the order becomes a market sell order. This is the same as themarket-if-touched order, but speciﬁcally to sell your position.
Placing an order is not a simple process, especially for the beginner.The variations are many, and the consequences of being wrong are great.This is why, when asked by new traders about the type of broker to get, Istrongly recommend a full-service broker—they can and will take the timeto walk the novice trader through the intricacies of the system, generallyprotecting the traders from themselves. Even after many years of trading,I still ﬁnd a full-service broker very helpful, especially when I am trying to
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do anything out of the ordinary, anything that is new to me, or somethingthat I haven’t done in some time.
HOW TO PLACE A DELTA NEUTRAL TRADE
To demonstrate this process, let’s take a look at a few delta neutral orders.
Straddle Example
Trade: 1 Long June XYZ 50 Call @ 3.50 and 1 Long June XYZ 50 Put @ 4.Place the order by saying: “I have a delta neutral spread order. I want tobuy one June XYZ 50 call. I want to buy one June XYZ 50 put.”Explanation: You then have to decide if you want to place the order at-the-market or as a limit order. A market order must be executed immedi-ately  at  the  best  available  price.  It  is  the  only  order  that  guaranteesexecution. In contrast, a limit order is an order to buy or sell stocks, fu-tures, or option contracts at, below, or above a speciﬁed price. If you wanta limit order, you would say, “I want to do the straddle as a limit order at adebit of 7.50 to the buy side.”
If you place each part of the spread as a separate order, you run therisk of getting ﬁlled on one side and not the other; and there goes your riskcurve. If you are going to do this, you need to carefully pick some periodof low volatility in the middle of a very fast market. You need to wait untilthings settle down a little bit. What happens if your chosen market is be-tween two strike prices? Be clear! State the strike prices you want.
Those  of  you  who  have  traded  before  probably  already  know  whyclarity is so important. Most orders consist of buying the stock and sellingthe puts. This buy-sell combination on a spread is pretty normal. You haveto  be  explicit  when  you  place  an  order  to  make  sure  you  get  what  youwant. Before calling your broker, always write orders down on paper or,better  yet,  in  a  trading  journal.  Every  order  you  place  with  a  broker  isrecorded on tape. If you make a mistake in the order process, you are re-sponsible  for  that  trade  no  matter  what.  By 