clifp
Give me a museum and I'll fill it. (Picasso) Give me a forum ...
- Joined
- Oct 27, 2006
- Messages
- 7,733
Over the last decade I've average between 50 and 150 trades a year. About 30ish are equity (include no commission ETFs) and the balance options.
My working theory is that writing puts or calls reduces portfolio volatility with minimal loss of performance. It was gratifying meeting with a sharp Schwab portfolio manager with $300 million in asset espouse the same philosophy. But after reading Micheal Lewis book I am done, the front runner have killed all my hope of making money writing options.
My understanding of what is going is as follows, but it is complicated and there is a decent chance I wrong, so I am very open for discussion.
Options trading circa 2002-2005
Say I owned 1,000 shares of XYZ that wanted to write a cover call.
I'd use the Schwab Trading platform Street Smart Edge which provides level 2 quotes so I could see the bid and ask size.
My screen would look something like this for slightly out of the money call call with S&P200 company.
Bid 5@$1.00, 10@$1.00, 10@$1.00 50@$.95
Ask 10@$1.10, 100@$1.10, 50@1.10 5@$1.15
I'd look at that see there was more selling volume than buying volume so I'd submit a limit order for selling 10 calls @$1.05.
Now maybe another person would drop their price to $1.05, but I didn't really care since I was the first one at the price my order would be executed first.
If on the other hand the bid and ask volumes were reversed. I'd probably set my price at $1.10 in hope that the guys wanting to buy 50 or 100 would take everything.
While I did do some calculations since I am only making 2-10 trades month, I wasn't super analytical. Sometimes I get the order other days I wouldn't.
Still I would try and save a $.05 at 10 contract it was $50 and if save a nickel 20 times a year that was a $1,000
But for past few years I notice a change in option trading. Even though daily volume has increase modestly, the number of contracts for sale or bid on has increase several times. I also notice that a soon as I entered $1.05 instantly a bunch of other contracts were being offered $1.05.
Now I naively thought being the first person to offer to sale a call at $1.05 I'd be the first one to do a trade at the price. After I reading the book, I now understand that because they front run my order. I'm no longer the first person on most exchanges cause of the fast connections. I also noticed the most of the time when option order is filled the first order is for 1 contract.
I now understand that when someone puts in a order to buy 100 contracts at $1.05 (which they are enticed to do by false ask orders). What happens is they buy my 10 contract and 1 HFT contract. But all of the other ask order disappear.
The buyer only has got 11 of the contracts he wanted so the HFT guys will offer him the remaining contracts at $1.10 or maybe even higher. Their computer will now know there is real buyer who actually wants to own call options for more than a few milliseconds.
If on the other hand the order is for only 10 contracts, the HFT trader will jump in line and sell the contracts $1.05 and then immediately offer to buy them at $1.001 (yes a 1/10 of cent)
As it it option trading is zero sum game. But it seems like a negative game now. If I lose anywhere from $.01 to $.05 per contract because of front running another per cent or two because of commission.. and say write a covered call each quarter it seems to me I am start 8% to 25% in the hole...
I'll start again but only with a less slanted playing field.
My working theory is that writing puts or calls reduces portfolio volatility with minimal loss of performance. It was gratifying meeting with a sharp Schwab portfolio manager with $300 million in asset espouse the same philosophy. But after reading Micheal Lewis book I am done, the front runner have killed all my hope of making money writing options.
My understanding of what is going is as follows, but it is complicated and there is a decent chance I wrong, so I am very open for discussion.
Options trading circa 2002-2005
Say I owned 1,000 shares of XYZ that wanted to write a cover call.
I'd use the Schwab Trading platform Street Smart Edge which provides level 2 quotes so I could see the bid and ask size.
My screen would look something like this for slightly out of the money call call with S&P200 company.
Bid 5@$1.00, 10@$1.00, 10@$1.00 50@$.95
Ask 10@$1.10, 100@$1.10, 50@1.10 5@$1.15
I'd look at that see there was more selling volume than buying volume so I'd submit a limit order for selling 10 calls @$1.05.
Now maybe another person would drop their price to $1.05, but I didn't really care since I was the first one at the price my order would be executed first.
If on the other hand the bid and ask volumes were reversed. I'd probably set my price at $1.10 in hope that the guys wanting to buy 50 or 100 would take everything.
While I did do some calculations since I am only making 2-10 trades month, I wasn't super analytical. Sometimes I get the order other days I wouldn't.
Still I would try and save a $.05 at 10 contract it was $50 and if save a nickel 20 times a year that was a $1,000
But for past few years I notice a change in option trading. Even though daily volume has increase modestly, the number of contracts for sale or bid on has increase several times. I also notice that a soon as I entered $1.05 instantly a bunch of other contracts were being offered $1.05.
Now I naively thought being the first person to offer to sale a call at $1.05 I'd be the first one to do a trade at the price. After I reading the book, I now understand that because they front run my order. I'm no longer the first person on most exchanges cause of the fast connections. I also noticed the most of the time when option order is filled the first order is for 1 contract.
I now understand that when someone puts in a order to buy 100 contracts at $1.05 (which they are enticed to do by false ask orders). What happens is they buy my 10 contract and 1 HFT contract. But all of the other ask order disappear.
The buyer only has got 11 of the contracts he wanted so the HFT guys will offer him the remaining contracts at $1.10 or maybe even higher. Their computer will now know there is real buyer who actually wants to own call options for more than a few milliseconds.
If on the other hand the order is for only 10 contracts, the HFT trader will jump in line and sell the contracts $1.05 and then immediately offer to buy them at $1.001 (yes a 1/10 of cent)
As it it option trading is zero sum game. But it seems like a negative game now. If I lose anywhere from $.01 to $.05 per contract because of front running another per cent or two because of commission.. and say write a covered call each quarter it seems to me I am start 8% to 25% in the hole...
I'll start again but only with a less slanted playing field.
Last edited: