look like a good dealconsidering they’re free. But that information isn’t without its 
 
 
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drawbacks, including the fact that you have to sit and watch foryour stock picks to scroll by. Then you have to be able to interpretwhat you see. For instance, if 50 IBM 17% scrolls by and the price isin green, do you know that means 5,000 IBM shares traded on theoffer at 117/4? (If it were red, that may reflect that the last trade oc-curred at the bid.) And when it’s a fast market, the “50” goes awayas does the change on the day.
Then there are the Web sites—Smart Money.com, ClearStation.com, BigCharts.com, SmallCapCenter.com, DBC.com—that offerfree quotes services. Just type in the quote symbol you want, andup pops a price and the change from the previous night’s settle-ment. Typically, these quotes are delayed 20 minutes from the cur-rent market, which may be okay if you are just keeping track ofyour holdings. But in a fast-moving market, a lot can happen in20 minutes.
Similarly, option quotes can be obtained on a variety ofWeb sites, including CBOE.com, Amex.com, and my Web site,1010WallStreet.com. If you typed in a stock symbol, such as IBM,you would receive the entire options chain with various strikeprices and months, including the one-year and two-year LEAPS.These are snapshot quotes, meaning I must hit “refresh” each timeto receive an update. That might be sufficient if Im actively tradingand tracking one or two stocks. But if I have a dozen differentstocks to keep track of at any given time, this kind of service maybe more of a hindrance than a bargain.
If you require up-to-the-second information, Particularly onmultiple stocks, you need live, streaming quotes. For the active in-vestor and retail speculator, this is essential. Given the competitionin the marketplace and the ease of online dissemination, live quotesare a fairly reasonable proposition, starting at about $60 a month.That quote service would pay for itself each month if it enabledyou to make a small profit, even a teeny (one-sixteenth) on a 10-lot(10 x 100 shares per option x 0.0625 = $62.50).
Plus, the minute you include options analysis software in thepicture, your quote information needs change. Software packagesoften demand a certain type of live quote, usually streaming quotesfor option scans and real-time profit-and-loss updates. Again, thesepackages may not be necessary if you are only buying covered callsfor stocks for which you have a bullish outlook. But if you are, oranticipate becoming, an active retail investor employing a varietygetting the right tools 175
of strategies, you must consider software—and the quote servicesthat they require.
Before we launch into software, the next “tool” category, it’simportant to know that there are several different delivery meth-ods for live quotes. The most popular means is the Internet, whichis appealing to many traders and speculators who are used to anonline venue. In fact, a number of quote services saw rapid appreci-ation of their share prices as the world began to realize that theInternet would free quote vendors from satellite and “hard-wired”delivery solutions. But there are potential drawbacks to using theInternet for quote delivery, including the speed and capability ofyour own Internet connection. If you have a 28.8 modem and you’retrying to pull down quotes for 3,000 stocks that have options onthem, well, good luck .. . that’s going to be about as easy as tryingto suck motor oil through a straw—at 30 degrees below zero!
If you have a cable modem or DSL connection to the Internet,that will speed up the process considerably. In a perfect world,cable and DSL access should allow you get quotes nearly as quicklyas with a direct connection. But, of course, there is no such thing asa perfect world. The speed of cable access depends on how manyother users are trying to access data at the same time. The morepeople who are on the Internet via the same cable service that youuse, the slower it will pull quotes, and the longer it will take for thevendor to push quotes out to its subscribers. Many of the paid In-ternet sites can only pull through 500 symbols at a time because oflimitations in bandwidth.
DSL is fast, but the service does have some geographic limita-tions. You cannot access this service from every location becauseproximity to the DSL source is a limiting factor. That’s why manyserious traders have satellite dishes to receive their quotes directlyfrom the vendor. Most of us consider that to be the most reliableservice when you absolutely, positively must have live quotes anymoment that the markets are open.
Being a premium distribution method, satellite dish is also themost expensive. But it’s what you’d expect an extremely activeretail investor to have. No office, no trading room on Wall Street de-pends on quotes via the Internet. If a brokerage had only Internet-based quotes, it would lose a majority of its customers pretty fast.And the bigger the brokerage, the more they know that their clientsare a sophisticated group, including hedge funds and institutional 
 
 
 
 
 
 
 
 
 
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traders, who have their own direct connections. Thus they have tohave the same direct market information as the most sophisticatedof their customers.
There is a long list of quote providers who offer direct or“hard-wired” connections, including Thompson Financial, Track-Data, ILX, Bloomberg, Reuters, S&P Comstock, and others. Manyprofessional trading firms have multiple services. At Mercury Trad-ing, we have at least two at any given time. Given the expense, Iwish we didn’t have to use multiple services. But for the volumeof trades that we do, it’s imperative that we have a depth of pricequotes and that is impossible to receive with only one service. Inaddition, having multiple services allows us to compare what theprevailing quotes are and see if one service is falling victim to band-width constraints that cause it to throttle-back its quotes. Since weare competing against other professionals both to price and tohedge our option positions, a stale quote could cost us hundreds ofthousands of dollars in a matter of seconds.
For every stock on which options are written, premiums arequoted for calls and puts at various strike price and variousmonths. The more active, or volatile, a stock, the more quotes willbe available. And each strike price has two different quotes; one forthe call and one for the put. Take a stock like Rambus (RMBS) thathas moved from $57 to nearly $500 (52-week high 471, 52-week low57). There would be options quoted at prices within that vastrange, each with its own quote, according to expiration month.That results in a gibberish of potentially confusing, multiple-letterquotes like RMQAA (the January $5 strike) and RQMAA (theJanuary $105 strike). Stocks like RMBS choke the Options Price Re-porting Authority (OPRA—no relation to the talk-show host!) asRMBS may have 300 strike prices, each with a call and put, for atotal of 600 potential price changes each time RMBS ticks up ordown an eighth!
Or take the SPX, the options based on the S&P 500 cash mar-ket, which may have strikes between 1200 and 1650, in $5 incre-ments all the way up. As the index moves, the underlying call andput quotes also change, say, from 127% bid and 127% offered, to127% bid and 127% offered, each time the S&P 500 future ticksup. There could be 400 strike price changes, both calls and puts,each time the underlying security changes in value. This also illus-trates the bandwidth problem for Internet-based quotes, and alsogetting the right tools 177
shows why you need multiple quote services, particularly thesedays when there are 3,000 stocks with options compared to the 80stocks when I began.
software
Now that you’ve decided that you’re an active-enough trader tohave a premium quote service, you must take a look at the kind ofhelp that is available to you to analyze the options market. That'sone of the reasons I believe database mining will be an importantfield in the future. Given the breadth of raw data, be it prices orvolatility, there is a need to study and manipulate this informationin a meaningful way. For example, you could look at a database ofstocks and (if you were a value-oriented investor such as WarrenBuffett) you might want to see companies that have a price-to-earnings (P/E) ratio of less than 20. Or you may be posing moresophisticated database queries such as scans based on price,volatility, time to expiration, increases or decreases in volumeor volatility, and so on. The more you ask a program to do, themore sophisticated the software must be.
Plus, you may be analyzing both stocks and options, whichoften require separate programs. For stock analysis, such as basedon price momentum, break-outs, and so forth, you may choose asoftware system such as TradeStation, MetaStock, or OmniTrader.For options, you might choose a program such as OptionVue 5,OptionStation, or OptionOracle. Each of these has various pro-grams to assist you in technical analysis according to your tradingmethodology and criteria. Whatever system you choose, the mostimportant consideration is the accuracy of the models behind thesoftware. Simply put, you must choose a program that is based ongood, solid mathematics, and not a lot of programming short-cutsthat can result in erroneous, inaccurate analysis.
Again, this goes back to the key question of what kind of traderor speculator are you? If you’re the casual investor who is lookingto buy a call now and again, you may not need the high-priced, lux-ury model among options analysis. But the more serious you areabout trading options, the more programming firepower you musthave at your disposal. The key difference comes in with iterations,which in simplest terms is the way computers count. If you’re usinga basic program, perhaps a simple tool that’s available online, the 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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program may use one or two iterations to come up with an approxi-mate valuation for an option. Thus, a program using only two itera-tions may determine that a particular option should be valued at6.75. Now, another program, using four iterations, might furtherrefine that valuation to, say, 6.70. With six iterations, you could getto 6.65, and so forth. The difference may not mean much to you, ifyou’re trading two or three stocks with a one-year timeframe. Butif you're an active option investor or professional trader, that one-eighth or one-sixteenth difference in valuation can, indeed, becostly. The big options programs that I use, for example, have 17iterations.
In addition, there are at least a half-dozen options pricing mod-els that use different pricing models, whether its Black-Scholes,Cox Ross, Gastineau, or Binominal. Most of those theories will re-sult in calculations within a nickel of each other. But, again, themore sophisticated your needs, the more sophisticated your toolsmust be. Put another way, the more accurate you must be becauseof your short timeframe or the amount of risk (leverage) that you'recarrying as a professional, the more demanding you must be of thetools at your disposal. As you can imagine, when options move todecimal pricing, the accuracy of the models will carry greater im-portance because, as of this writing, we still trade most options inminimum ticks of an eighth. So if] think an option is worth 5.50 andyou think it’s worth 5.61, there isn’t any way for either of us to cap-ture that difference. But with penny increments, disparities assmall as a cent may be exploited.
Again, an investor with a one-year timeframe is probably notgoing to care if the software program he or she is using has mis-priced an option by an eighth or quarter. But when it comes to meor one of my traders on the floor, we must have the utmost of confi-dence in the models that we’re using. Particularly when trading ac-tivity on the floor is fast and furious, floor traders must rely on theintegrity of the options-pricing model that they’re using to make amarket. Otherwise, it’s like sailing into a rock-strewn harbor with-out a map and channel markers.
But you can’t let the software alone, make your decisions. As |tell my traders and the customers of my brokerage firm and asI teach in my seminars, before you place a trade, you should be ableto graph what your trade looks like before you establish it. Youmust be able to give a pictorial representation of the risks you face.getting the right tools 179
For example, if you’re buying a call, you have to know that your risklooks like an inverted hockey stick (Figure 9.1).
The call purchase means you have a defined risk upon enter-ing the trade, which is the premium you paid for the call. Your op-tion should start appreciating in value once the stock or indextrades above the strike price. The upside is virtually unlimited.
Or, a back-spread trade, in which you are long more optionsthan you are short, looks like a “V” when you chart the risk sce-nario (Figure 9.2).
With a graph, you can visualize and interpret various “whatif” scenarios. You can see, clearly, how changes in volatility willimpact the options position, or you'll see if time decay hurts orhelps your position. You'll be able to see where your risk is, andwhether your risk is adequately offset by your potential reward.Then, you can overlay all of your positions in the same graph,which gives you a clearer picture of the impact of market moves onyour entire portfolio.
It’s helpful that a computer can do that for you, and that thereis software that will enable you to construct a graph of a trade withonly a few keystrokes. But if you can’t tell me, given five minutes
Figure 9.1 long call
 
Profit / Loss (¥) and AMZN Common Price (X) Risk Graph
 
 
 
 
Source: Created by StockmarketWorkshop.com. 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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Figure 9.2 backspread
 
Profit / Loss (Y) and IBM Common Price (X) Risk Graph
 
 
 
Source: Created by StockmarketWorkshop.com.
and a bunch of price points, where the risk is in a particular trade,then you don’t fully understand what you’re doing. If you don’tknow that if you sell a call spread, the risk is the difference betweenthe two strike prices—the one you're selling and the one you'rebuying—then you shouldn’t do that trade. Why? Because you can’trely on any computer program or software to make your decisionfor you.
You need to be able to show (yourself, at least) that the callyou sold would make money until a certain price point, at whichyou begin to lose money—but not indefinitely because a protectivecall that you’ve purchased will flatten out your risk at another pricepoint. Unless you’re dealing with many complicated strategies, youshould be able to show what your trades looks like. Otherwise, therisk is too dangerous, because you don’t understand what you’regetting into. Options, like any speculation, require that you do yourhomework. It’s wonderful that your software program can generatea chart in three-dimensions with the colors of your choice. But ifyou haven’t a clue as to how it arrived at that conclusion, thenyou're not ready to trade.getting the right tools 181
advisors
I decided to address advisors and brokers separately, even thoughthe best brokers serve both functions. I'll address the brokerageservices in a moment. So first, let’s look at the independent advi-sory services that are available. They include well-known names inthe options industry such as Bernie Shaffer, Larry McMillan,TheStreet.com, and 1010WallStreet.com, a Web site that I foundedbut no longer own. First, let’s address the issue of why you wouldpay someone a fee for specific advice on the market. The only fea-sible answer is you believe their advice is valuable enough tospend money on.
In this field, there are registered investment advisors (RIAs).One example is Fidelity Insight, which is operated by formerFidelity fund manager Eric M. Kobren. This service tracks the per-formance of various Fidelity fund managers and, for a fee, will assistclients in jumping from fund to fund in hopes of capturing the bestreturns. Most RIAs will charge a fee that is normally a small per-centage (such as 1 percent) of your assets for their services. TheRIA designation is not an automatic endorsement of the value oftheir advice, but rather shows that they are subject to the oversightof the SEC and the NASD.
Other investment services are not RIAs, but rather publishmarket information and insight, either in a newsletter or on a Website. Of these, advisors such as Bernie Shaffer, Larry McMillan,and 1010WallStreet.com operate under an interpretation of free-dom of speech guaranteed by the First Amendment. As long asthese advisors do not take commissions, they can print their opin-ions and analysis about broad market trends. The credentials ofany advisor must include both intelligence and expertise in what-ever is being analyzed. You have to have both. I certainly thinkof myself as a smart guy, but would you want me to tell you aboutairplane wings? I could read up on the subject, but I could nevertell you enough about airplane wings to be considered an expert.But when it comes to options, my 20-year career as a tradershould speak for itself.
Beyond that, you must ask yourself if this advisor’s invest-ment outlook, theory, and general style matches your own. If an ad-visor is too aggressive or too conservative for you, then chancesare this is not the right fit for you. If you are interested in tech 
 
 
 
 
 
 
 
 
 
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stocks and an advisor specializes in the financial sector, again, thisis not the right advisor for you.
When you’re trading or investing, give yourself as many toolsas you can afford, but make sure you are going to use the servicesthat you pay hard-earned money for. Just as software is going tohelp you, especially if you’re watching multiple markets, so will oneor more advisors. An expert advisor can give you insight intobroad market trends or a particular sector that you’re watching.But none of these advisors is going to enter a trade for you. Most ofthe Web-based advisory services will not buy and sell for your ac-count. That’s up to you. What a good advisor will do is give you in-sight into the market, and point out a few things that you may nothave considered before. At 1010WallStreet.com, they remind you ofkey industry conferences, new product introductions, possibletakeover targets based on unusual options activity, and in otherwords, expand your knowledge base and investment opportunities.
brokers
There was a time when your broker was next to your mother oryour significant other on your telephone speed-dial. You talked toyour broker as much as (if not more than) you talked with yourbest friend. Your broker kept you informed and, if you were a goodcustomer, made sure you heard first. But that kind of service cameat a price in the form of high commissions. Then came online bro-kerage and discounted commissions. Then brokerage commissionsdeclined and at most firms, the services dwindled. If you’re a so-phisticated investor, you may not need hand-holding to place atrade. But there may be other services that you do need. Investorsdo not live by discount commissions alone.
There is a variety of brokerage services out there, to fit yourparticular investment demands. In some cases, you may want tohave a broker act like an advisor, to assist you with your tradesand, in some cases, to have the authority to execute a trade or ad-just a position with your permission if you’re not available. Havingthat watchdog for your position can be invaluable. What if you’rea doctor in surgery when the market moves 300 points? Or you’re areal estate agent who’s in a million-dollar closing and you can’twatch your position during the trading day.getting the right tools 183
Maybe you don’t need help constructing a trade. But youmight very well need someone to watch your position for you andalert you by pager or even adjust your position for you. Our goalwhen we established our brokerage firm, PTI Securities & Futures,was to give customers access to experienced floor traders who un-derstand option strategies and how to execute spread transactionsand deliver full service at discount prices. Services offered by usand other good full-service brokers is invaluable, especially whenyou’re trading index options, such as OEX.
As American-style options, OEX can be exercised at any time.But unlike an equity option that involves the purchase or deliveryof stock, OEX is exercised for cash. That’s an important considera-tion if you’re out of touch with the market or out of contact withyour broker. Say you’re on a plane. You’re short OEX options andthe calls that you sold are going to be exercised against you intocash. A bigger problem is if these OEX were used to cover stockholdings. Without the protection of the OEX options, you’re sud-denly naked long the stock in a market that could be opening downthe next day.
For example, let’s say I did an OEX bull call spread, buying the870 calls and selling the 890 calls. On Monday of expiration week,we'll say the index is at 875. On Tuesday, it’s up to 880 and onWednesday it’s at 890. That’s great for me because now my spreadis in-the-money. On Thursday, it’s at 910, and the 890 calls that Isold are also in-the-money. While the 870 calls I bought are doingvery well, | do face the very real possibility of the buyers of the 890calls exercising their option.
Now comes the tricky part, at least for American-style optionslike the OEX. Every day, there is a 15-minute gap when stocks stoptrading but the stock index futures pit is still open. This gap is be-tween 3 p.m. and 3:15 p.m. Central. On the close, the OEX traders,who ail hedge their positions throughout the day with S&P 500 fu-tures, pay even closer attention to the futures. Now, let’s say that at3 p.m. the S&P cash market is at 1501 and futures are at 1505. Thenthe cash market closes. At this point, OEX and S&P 500 cash haveall closed higher on the day.
But this 15-minute window is a time of unpredictability. At3:05 p.m. Central, S&P futures are up to 1507. Then at 3:08 p.m., dis-appointing earnings are reported for some large S&P stocks. S&P 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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futures begin to decline, and by 3:10 are at 1498 and at 3:11 are at1495. Let’s take a look at this scenario: OEX options rose and S&Pcash was higher, but S&P futures traded lower after the cash priceof the OEX was pegged at 3:00. And just before the close of theCBOE, the buyer of your 890 OEX options had exercised the callsfor $20 per contract in cash.
Meanwhile, you were long OEX options from 870. Without ex-ercising them, you are naked long these calls the next day, whenthe decline in the S&P futures market could foreshadow a drop inthe overall market and, of course, the OEX. Maybe OEX calls will bedown from 910 to 900 or below. With a discount broker, you wouldhave been on your own to monitor that trade. But with a full-servicebroker, you may have had the backup to watch your position if youwere unavailable.
My obvious bias toward full-service brokers aside, it’s impor-tant for retail customers to understand what they’re getting withany broker they pick, either a discount firm or a traditional, full-service house. One consideration is how your trade is executed. Afull-service broker may have its own brokers on the floors of thefour major options exchanges. Or it may use a network of indepen-dent brokers across the various trading floors, as PTI does. How-ever, some of the largest full-service brokerages have little or norepresentation on any of the trading floors. Unfortunately, the un-witting investor is being charged full price for a lower level ofservice than many discounters offer. In other words, just like thecheapest discount brokers, some firms farm out their option execu-tion to one or more firms, which can affect the time and price atwhich your trades are executed.
Let’s take an example of a discount firm we'll call “Gee-WhizTrade,” which clears through New York Brokerage House. But NewYork Brokerage House doesn’t have its own options brokers on thefloor. Instead, they farm it out to somebody else. That firm couldthen, in turn, pass it on to yet another party for execution.
With that kind of chain, is there any wonder why the customerwho is used to the instant-gratification of trading stock on the phoneis frustrated by the execution in options? The customer sees the op-tion he or she wants is bid at 4% and offered at 44. But by the timethe order hits the trading pit, the price has moved, and their broker-age blames the market makers. Let me assure you, my peers at theCBOE, AMEX, PCX, and PHLX would like nothing more than to tradegetting the right tools 185
with you. We aren’t dodging your orders when they hit the pit. Withseat leases at $5,000 to $16,000 per month, you can bet we seizeevery opportunity to trade. If your broker can’t get you fills you arehappy with, try someone else. You will probably find that the firmyou were dealing with was the problem, not the market makers.
Professionals always want to trade against the public. Thinkabout it. I’m standing in the pit where a broker is offering options,and the market is 4% bid and 44 offered. In a split second I can yell,“Buy ’em,” and execute the trade at the market. The public investorcan never keep up with that pace. At best, the retail investor’sorder takes 10 to 15 seconds to travel from the broker to the tradingpit. Any time longer than my quick, twitch response means speed ison the side of the professional, at least for the first few seconds,which is all we need. Multiply that by thousands of public ordersper day, and you can see why brokerages are willing to pay fororder flow just for the chance to trade against it.
On the floor, the market is incredibly fast. We’re watching thebuyers and the sellers in the market. All the trades are visible; it’sno secret where the market is trading.
At home, retail customers are looking at delayed quotes,which is a snapshot of where the market was 20 minutes ago. Evenwith live quotes, it’s still a slow-motion scenario. By the time a cus-tomer keys in an order to buy 10 Micron January 140 calls for 34,the market could have moved. I may be able to buy those calls for afraction lower, say 3%. Now the market is 3% bid and offered at 31.Now when that customer order to buy at 34% reaches the floor,everybody wants to sell at that price. If you’re the most aggressive,you'll get that trade.
The professional trader who is buying order flow wants to sellon the offer and buy on the bid, but he doesn’t want to have thecost of exchange seats and other overhead to deal with. He’ll do histrading electronically, with a computer to offset his trades or hedgewith stock. He’s not obligated to make a market. Rather, he’ll matchthe National Best Bid and Offer (NBBO) quote. To play that game,though, you need to have thousands of trades to make a teeny here,an eighth there, and the occasional quarter, to replicate the scalp-ing that we do on the floor. That’s only possible if you buy cus-tomer order flow.
Trading against someone who has a different timeframe fromyou can be profitable and is how payment for order flow came into 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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being. Simply put, payment for order flow began on the stock side ofthe world when smart folks figured out that if you could filter out theprofessionals and just trade against the investing public, your num-ber of winning trades and potential profits were larger. Firms beganlooking to pay for this advantage by selecting the most likely retailoutlets, such as most discount brokers, and paying $0.01 to $0.02 pershare for the opportunity to trade against this uninformed orderflow. If the average spread is % ($0.12 per share) between the bid andthe offer, the firm buying the order flow would expect to capturepart of that differential on a majority of its trades. As you can imag-ine, paying $0.01 for something you could make even $0.0625 (Ys)can be a very nice business indeed. In fact, Knight Trimark (NITE)built a multibillion-dollar business around the concept.
As of this writing, payment for order flow is just becoming areality in the options world. Like most of my competitors, I loathethe idea, but realize it is coming whether I endorse it or not. There-fore, we have engaged in a soft-dollar exchange of our massivestock trades for option order flow, but I know the next step for uswill be outright buying of option orders from brokerage houses. Asyou can imagine, the customer rarely benefits from schemes suchas payment for order flow, but as long as firms are looking for addi-tional ways to squeeze more profit from their customers, it will con-tinue. What the customer must ask, therefore, when choosing abroker, is how are trades executed? Does your brokerage sell theorders? Does it have its own brokers or a network of brokers? Doesyour order get passed on to one or more firms before it’s executed?
Most importantly, does your broker know about options? Somany times we hear in seminars from retail investors who say theirbrokers are great with stocks, but are either not knowledgeableabout options or try to talk them out of using options.
There is room for all types of brokers in this marketplace, thediscount firms and the full-service houses. And there may be room forboth types of brokers to handle your portfolio, the discount firms forthe easy trades that you’re the most comfortable with and the full-ser-vice firms for the tr