We've had some fast-market days recently. What do fast-market conditions and low-volume days have in common? Under both sets of conditions, you may have trouble filling multi-legged positions.
What can you do? You can split such orders, but other Options 101 article have pointed out the danger that might be inherent in that practice.
Just before the open Tuesday, September 30, futures had been in the green although they had slipped off their pre-market highs. Immediately after the open, however, many equities dove, sending indices and index-based securities such as the SPY lower. Just before the release of important economic numbers at 9:45 and 10:00 am ET, the SPY was testing the afternoon low from the previous day.
Five-Minute Chart of the SPY:
The arrow points to the last red candlestick, forming a few minutes after the 9:45 am ET release and just before the 10:00 am release. It's conceivable that some traders thought the SPY was likely to break through that 196.8-ish short-term support and head lower again. Because the VIX was up above 16 again at the time and the early morning volatility had likely inflated IV's, the prices of puts were likely inflated. A trader who wanted to buy a put to play a hunch on a directional trade would have (or at least should have) known that the put was expensive. Perhaps the trader preferred to buy a put debit spread or sell a call credit spread instead to get around the problem of expensive options. If the options being bought are expensive, those being sold are also likely to be expensive.
Fills might have been difficult at the time, especially for multi-legged trades. Let's think about how a trader could get into trouble legging into a vertical under such conditions. Perhaps an anxious trader who was trading a hunch that the SPY was about to break through support thought she would buy a long put first, when it was cheaper than it was about to be. Then she would sell the second put at a lower strike, doing so as quickly as possible to avoid risk. Perhaps that put would have even gained in price while she was legging into this second half of her planned vertical, she might reason. Perhaps she was wasn't so anxious and was so convinced that the SPY was heading lower after the release of those two numbers that morning that she planned to wait until after their release before selling the second put. She might think that if the SPY headed lower, as her charts and hunches told her it might do, she could sell it for more money and better hedge her long put. The put debit spread would be cheaper.
Our theoretical trader was fighting two problems. She was definitely buying an expensive put that morning. Even if the SPY had headed lower after the release of those two numbers, it's possible that the implied volatilities might have eased unless the numbers were shocking and the drop significant and violent. Therefore, even if the SPY had headed lower, the put she wanted to sell might be less expensive than it had been a few moments previously. That's one type of slippage that can be encountered when such trades are split.
Another problem she definitely would have encountered unless she sold that put immediately was that her assumptions and technical analysis had been wrong. The SPY turned around on the 10:00 am five-minute candle and spiked higher. She would have been scrambling to sell the long put she already held or the one she had intended to sell against the long put. This is another way someone splitting a multi-legged trade can encounter slippage: an adverse market move before the multi-legged position could be completed.
While I was not the hapless "theoretical" female trader trying to trade a vertical that morning, I know about the problems associated with legging into complex positions. Slippage due to an adverse market move is one that I often encounter and must accommodate in my long-range plans. I trade a complex position that's composed of many parts. There's no way that I can close that position all in one trade. Even if I set up orders to fire all at once, it's unlikely that they would fill all at once. I might be left with an extremely unbalanced trade. I do my best to keep the trade's risks balanced as I take something off here and something off there, keeping the "today" profit-and-loss line as flat as possible while I do so. I can't always predict when markets will suddenly reverse course. If I could, I wouldn't be trading a complex, balanced trade but would instead wait for those times with a pure directional trade.
Low-volume days present some of the same difficulties. What is a trader to do if he doesn't want to encounter that kind of slippage but needs a multi-legged hedge on an existing trade or wants to enter a multi-legged directional trade?
Consider the following techniques: use as few legs as possible and place legs at higher-volume or higher open-interest strikes.
Volume and Open Interest about Mid-Morning, 9/30/14 for RUT OCT 14 Puts:
The RUT was near 1113 when this image was snapped, with the information shown here coming from Think-or-Swim. Imagine a trader who thought the RUT was about to collapse again and who wanted to buy a put debit spread. That trader would notice that the volume was strongest at the near-the-month 1110 strike, with open interest decent at that strike, too. Volume was okay for the 1100 and 1120 strikes, too, with the 1100 strike seeing the customary higher open interest that is found at such round-number strikes. In many cases, it's easier to get fills if at least one of the legs is as close to the money as possible, but those 1115 and 1105 strikes have far less volume and open interest than the 1110 and 1100 strikes. Looking at volume and open interest will often help you position your multi-legged trades where there's likely to be enough volume or open interest to get them filled.
I like to keep my trades all nice and tidy and not have too many strikes open. If I've previously put a hedging call debit spread at once place, I'd prefer to put the next one at the same place. However, sometimes fills are easier if I put that hedging call debit spread at different strikes. Volume is often highest near the money, of course, and extrinsic value is highest at the at-the-money strikes. Sometimes rather than keeping things neat and tidy, I like to position my new hedging call debit spreads so that I'm selling a lot of extrinsic value and getting quicker fills, too. This technique doesn't always work, but I've found many times when I'm trying patiently to get a fill that matches my original hedging call debit spreads that I get an immediate fill once I change the strikes so that I'm buying and selling strikes closer to the underlying's current price.
What else might help with fills? Be aware that when you place a trade, you're asking someone else to take the opposite side of that trade. If you want a position that will benefit from a downturn, you're asking the other party (or parties) to take a position that will be hurt in a downturn. If you're a person who trades by the Greeks, you're asking someone to take a positive-delta position when you're trying to take a negative-delta one. You might have more luck in such cases if you wait for a rise in prices before you expect a fill, even if it's just a small rise. The opposite is true if you're trying to get a fill on a positive-delta position in fast-market or low-volume trading conditions. You may have to wait for a small dip before you can get a fill. I edited this article yesterday afternoon, and I did have to wait for small rises to sell a couple of call debit spreads in order to lower my overall deltas.
Also, if you're accustomed to trading right at or maybe even just under the mark or mid-price between strikes, you may have to alter that practice during low-volume or fast-market conditions. You may have to buy closer to the ask and sell closer to the bid than you're accustomed to doing. I found that to be true when I was moving butterflies on Friday afternoon. There's a time to carefully work a trade to get the best price, and then there are conditions when it can be penny-wise but pound-foolish to try to work a trade. You just need a fill.
If you're trying to get a fill because you want to participate in an anticipated move, you have the opportunity to throw your multi-legged order out there at the price you want and hope that it fills. You can walk away if it doesn't. If it does, however, you want to be aware that you may not have an easy time closing the trade.
If your goal was to hedge a trade, you may have some leeway in the strikes you employ in your multi-legged order, looking for strikes with ample volume and open interest. If you've reached an adjustment point or max loss, you may not have that leeway. Remember that there are going to be occasional times when you might have to leg out of a trade. Plan the order in which you would do so. Remember that if you buy in the long option and leave the sold option uncovered, margin considerations may cause you problems. Try to keep the trade as balanced as possible while you're legging out of the trades. Plan for what you would do if you absolutely cannot get a fill on a multi-legged position. Yesterday afternoon, I was able to get fills on some butterflies I was selling and the lower ones I was buying. However, in one case, my order was originally placed at 1:52 pm CT and filled only at 2:00 pm CT, with precious minutes lost while RUT prices changed. I usually wait until after 2:00 pm CT and maybe as late as 2:30 CT to adjust, but I anticipated such problems on such an unsettled day and began adjusting a bit earlier than normal. CBOE is the only exchange filling RUT butterflies, and their mid-prices were way above the composite mark price to buy those flies. You pay or you don't get your order filled.
I recommend some "what if" testing so that you're practiced at thinking about how you would manage if you could not get easy fills on multi-legged positions. If you're trading an SPX or RUT position and can't get CBOE fills, can you hedge with a SPY or IWM position instead, with such fills perhaps more likely? If you're trading an equity with that equity's performance closely conforming to the behavior of the SPX, can you use a SPY position to hedge? Does your brokerage allow you to beta-weight your simulated trades so that you can estimate what and how many SPY positions you would need? Does your underlying have Weeklys? I don't hedge with Weeklys, but I know some traders have, in an extreme situation, rather than leave a position grossly unbalanced and vulnerable at the close. Practice what-if situations before you choose such a tactic. You obviously can lose money quickly with such hedges. Can you buy to close one of your sold options? Buy an extra long position? That's not going to be your first choice if such options are likely to be expensive, but what if it's your only choice if you absolutely cannot get a needed multi-legged or other fill in fast-market conditions or on low-volume days? I am not recommending that you just jump into a trade that may or may not work on such a day: I'm recommending that you practice what-if scenarios ahead of such days so you can determine how you might best remedy the situation.
Once you know what you would or could do in an emergency, you can relax. You are going to make mistakes. Your directional technical analysis or trading skills, no matter how good, are going to fail you from time to time. You are going to start legging out only to be faced with a fast switch that leaves you chasing the next trade. It's just part of trading. Plan so that it happens less often rather than more often.
I know this week was difficult for many traders. The last two months may have proven difficult for many RUT traders and now other traders are feeling the pain. I hope that as many of you as possible escaped any pain, but I know some are stressed and perhaps struggling with guilt and recriminations this weekend. We've all been there.
First, get away from obsessing over your trading screen and do something that brings you peace and joy for at least a few hours. Promise yourself that you'll get back to studying the trade before Monday's open, but you need the time to rebalance. Then, sit down and assess your risk, without guilt if possible. Learn from what has happened, but right now, guilt does not lead to calm and reasoned decisions. Decide what you can do to stabilize the trade so that risk--from either a further decline or a rabid relief rally--is ameliorated. If there is no way to ameliorate that risk, you may want to consider closing down the trade. None of us knows what happens next: this week has proven that. I certainly don't know. Don't believe that the markets "have" to do anything. They don't have to turn around. They don't have to move lower. All you can control is how you react to them.