Entering the Covered Call Buy-Write Trade Order

Below is a typical order entry form used by online brokerage firm optionsXpress.com for buy-write covered call trades – it will be similar at most online brokers these days. Notice how this order form is set up to incorporate all the elements discussed above. It is designed specifically for buy-write covered call trades.

Remember: options are always bought or sold to open or close. The order form is simplicity itself. Let’s walk through the steps necessary to place a buy-write trade in Cisco Systems (CSCO). Here are the trade details for opening our prospective CSCO trade:

We’re going to enter the trade as a buy-write, so we want the stock and call legs to be executed simultaneously at a net price – the debit.

For this reason we will enter a limit order in the form of a net debit order. This is a combination order, as we noted in the previous articles.

If the trade was run precisely at the quoted prices (19.75 to buy the stock, selling the calls at 1.25), the trade’s net debit would be 18.50. If we enter an 18.50 limit there is a good chance of getting a quick fill there, unless prices are moving or a huge number of orders are stacked up.

But can we do better than 18.50 – incur a smaller debit? A market order might get filled at an even higher debit, and there is almost never a good reason to use a market order for covered call entry, as noted earlier. Remember the show or fill rule: if you are running less than 10 contracts, the market maker might give you a quick fill at a slightly lower debit to get rid your order off the quote board.

So let’s instead try entering a limit of 18.45 or even 18.40, which respectively cut 0.05 and 0.10 off our entry price per share. While it may not seem like much, these extra nickels and dimes add up. Unless there is pressing reason to get the trade done right now, we will enter a lower limit price. The market makers might take it, particularly if they want to move a position in CSCO or need to buy the CYQED calls to close; and prices might dip during the day, giving us the fill we want.

NOTE ON GREED: While all traders seek the best fill, the order should bear some relation to the liquidity of the calls and the underlying stock. The tighter the stock and option spreads between bid and asked, the harder it is to get a better fill – a lower entry debit. If you find it difficult to get buy-writes filled on a consistent basis, your debit limit may be too low. In this case, your only hope of getting filled is for the stock price to drop just enough for a fill.

We enter the covered call order like this:

Figure 4.13

Combination Order to Open Covered Call

(Net Debit)

Figure 4.13 uses the buy-write covered call order form used by optionsXpress.com.

Our buy limit order is entered at $18.45 (instead of 18.50) as a day order. Note that the opening order balances, meaning that the number of shares matches the number of call contracts sold and put contracts bought:

Covered Call Order – Opening    
  Action Order Number
Stock leg Buying 500 shares of CSCO stock Buy 500
Call leg Selling 5 contracts of the MAY 20 Call STO – Sell to Open 5

 

The number of call contracts written should match the number of shares being bought. You can always write calls on less than all the shares bought or owned, but you cannot write a greater number of calls than the shares you own (or buy) unless you are approved for naked writing. If you wish to write against all the shares, be sure the number of shares and call contracts balances.

After filling in the order form, hit the Preview Order button. Review the order details and if correct, hit the Place Order button. We might not get filled right away on this order, since it is a limit order. In fact, we might never get filled. Prices might move away from (higher than) the order, or there might not be that much flexibility in the price (because spreads are tight). If the bid-asked spreads are tight, the only real chance of getting filled on a below-market limit price is for the stock to trade down slightly during the day, making a fill possible at the specified debit amount. If the stock is rising, however, the trade may move away from the limit price. We can always re-enter the order with a higher limit if not filled at our limit price. If it won’t fill at the lower buy limit, it may be necessary to raise the limit price.

Once filled, we will get a confirm (trade confirmation) by email from our broker, specifying the number of shares bought and contracts written. We will be long the underlying stock and short the calls written. We will be charged two trade commissions, one each on the stock and call legs of the trade. We will assume for discussion purposes that our fill on the trade was a net debit of $18.45 – saving a nickel per share. Thus our net trade debit on the open is $9,225.00, not including commissions.

If Combination Order Not Allowed

Not all brokers allow the combination order with a single limit price. If your broker does not allow them, you will have to run the order as two separate legs (this is so 1997):

  • Buy the stock, using a limit or market order;
  • Then write the calls (using an option order form), because you must own the stock before writing the calls;

If you have to enter each order as a limit, it is common to find you are chasing a fill on the position. For example, you get filled on the stock buy but not on the call orders, which may be caused by a too-restrictive limit price. And using a market order will guarantee poor fills, though it will on the other hand guarantee the order is filled.

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