When instructing our online discount broker as to the actions we want taken, we submit a customer order. These orders can take several different forms depending on our investment strategies and objectives. We can buy or sell; request a specific price or simply the best available price; we can stipulate an action given a particular circumstance; and we can use combinations of orders. Let’s look at the most common of these orders and the situations when we may utilize them.
Market Order:
This is the most common of customer orders where we ask the broker to buy or sell a stock at the best available price. It is also called an “unrestricted order” and will always be executed.
Limit Order:
This is an order to buy or sell a specific number of shares at a certain price or better. A buy limit order can only be executed at the limit price or lower. A sell limit order must be executed at the limit price or higher. These are particularly useful on low-volume or highly volatile stocks.
Stop Order:
An order to buy or sell a security when its price surpasses a specific price called the stop price. At that point the stop order becomes a market order. A sell stop order is placed below the current market value of the stock and is used to prevent or limit a loss or to protect a profit on a long stock position. For example, you may have purchased a stock for $20 per share and it has appreciated to $30. A sell stop order @ $25 will guarantee at least a profit of $5 per share (barring a gap-down in the price of the stock). A buy stop order is always placed above the current market price of the stock. It is typically used to protect a profit or limit a loss on a short sale (selling a stock you didn’t own by borrowing it). For example, if you sell short a stock @ $30 expecting to buy it back at a lower price but it starts going up in value instead, a buy stop order can limit your loss. It may kick in @ $32 thereby minimizing losses to $2 per share. Once the buy stop price is reached, the order becomes a market order.
Stop Limit Order:
This is a combination of a stop order and a limit order. Once activated, it becomes a limit order which means that it can only be executed at a specific price or better. The benefit is that the trader has precise control over when the order should be filled. The disadvantage is that it may never get filled. A sell stop-limit order is always placed below the current market price of the equity and is used to limit the loss or protect the profit on a long stock position. Once activated, it becomes a limit order. A buy stop-limit order is always placed above the current price of the stock and is used to limit a loss or protect the profit on a short stock position. Once activated, it becomes a limit order.
Summary of Orders entered Above the Market:
- Buy Stop-Limit
- Buy Stop
- Sell Limit
Summary of Orders entered Below Market:
- Buy Limit
- Sell Stop
- Sell Stop-Limit
Covered Call Trade Orders:
Most writers of covered call place their trades by legging in. This where a market or limit order is placed to purchase the equity and once executed, a second order (limit) is placed to sell the option. For maximum profits, these two legs should be executed simultaneously (Buy the stock and immediately sell the option. Do not buy the stock, go to the mall and then come back home to sell the option). Another methodology permitted by some online discount brokers (not USAA, the one I use) is to place a net debit order. This is where you buy the stock and sell the option at the exact same time, not for specific corresponding prices but for a limit net debit. For example, if a stock is selling for $20 and the A-T-M call is selling for $1.50, the net debit or amount we would owe is $18.50 ($20 minus $1.50). This way, even if the price of the stock and option change, the order can still be filled if it meets the requiremnts of our debit order. This would be particularly useful for investors who can’t be in front of their computers but want to execute a covered call trade. As stock investors and covered call writers it is critical to know and understand the different types of customer orders and the appropriate time to implement them.
Industry in the Spotlight– Paper Products:
This industry is up in value 27% in the last 6 weeks and 60% in the last 18 weeks. One of the best performers in the group is RKT which has been up in price 25% and 56% in the same time frames. This stock meets all our system criteria and has options. Let’s look at a current nchart:
RKT as of 8-20-09
The technicals are near perfect. We have uptrending moving averages with the short term above the long term and price bars at or above the 20-d ema. MACD is positive with the histogram neutral. The stochastic oscillator is rising indicating the bulls are in control. Volume has been impressive during the recent price surge.
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Hi Alan & Gang,
I trust everyone is busy this weekend with IBD! There is something I suspected last weekend and checked out in detail and confirmed today. Many IBD100 list stocks that are indicated as being non-optionable (by no little circle in upper RH corner) are so in fact. This weekend that includes ORN, TLEO, ININ, LL, EBIX, PEGA, SYNT, SHOO, & WXS. Am I missing something, or WHAT’S UP WITH THAT!? If in error, which it obviously is with simple checks, who best do I contact at IBD to complain?
– Doug
Doug,
This is something several of our readers have commented on . Here is a link to contact IBD:
http://www.investors.com/ContactIBD.aspx
A number to call:
800-664-2013
Most of the stocks you mention were listed as having options in previousd IBD lists….go figure!
Alan
Hi Alan:
I am a relative newbie in covered calls. Thank you for the information that you supply on your web site and in your publications.
In reading your latest message you state:
“For maximum profits, these two legs should be executed simultaneously (Buy the stock and immediately sell the option. Do not buy the stock, go to the mall and then come back home to sell the option). ”
Isn’t it okay to buy a stock and hold it for several days if it is appreciating in value??
Will not the covered call premium also increase in value as the stock price increases so by waiting for several days before selling the covered call, the covered call premium received will be greater??
Thank you,
Larry
Larry,
Your question belies the fact that you are a newbie to CCs. Given the scenario you paint, allowing share appreciation and subsequently selling the cc option will definitely benefit you. The problem is predicting the short term movement of any equity. My conclusion is that if you have selected a stock that meets your system criteria and are satisfied with the calculations, take the deal and run (but not too far because we need you nearby for possible management issues- exit strategies). In this regard, however, if you feel strongly that stock appreciation is a good possibility (based on technical and fundamental analysis, not a feeling or a tip you got at the water cooler), then you may opt for an O-T-M strike and plan for both option premium + share appreciation.
Alan
Hi Alan:
You have hi-lited RKT as a stock with good technicals. I was under the impression that the stochastic should be at or near the 20 level to consider buying. However, this stock has a stochastic that is already at the 80 level. Could you please comment on this? Many thanks.
Wendy,
The stochastic oscillator is a momentum indicator describing who is winning the battle of the bulls and bears. In this case, the bulls are in charge. As RKT approaches the 80% line, we know that the current market value is in the upper part of the current 14-d trading range.
Once it crosses this line, technically the stock is considered in the “overbought” range. However, I have seen stocks remain above the 80% marker for months. This is NOT a reason to abandon a stock although I do understand your concern. What we look for is a double dip below this line as a negative indicator and then factor this one indicator in with the other technicals.
See pages 73 to 76 of “Cashing in on Covered Calls” for more info on this subject.
Alan
Hi Alan:
Given that this market rally since March has been fueled by light to average volume and the fundamentals aren’t as great as the technicals for the majority of stocks, a lot of “experts” are expecting a fairly large correction. Under this set of circumstances how far would you let a stock that you have bought and have sold calls on drop before you close out your position??
Many thanks.
Wendy,
The rules (20%,10%, etc) as set forth in my book about exit strategies do not change. I have been on record as expressing concern about a possible market correction. To protect my portfolio from such an event, I have been favoring I-T-M strikes. Allow the option buyer purchase this “insurance” for you!
Remember also, that if you become concerned about the technicals of a stock, you can unwind that position at any time.
Alan
CTSH:
As a follow-up to the video currently playing on the homepage, I checked the current price and chart of CTSH and the corresponding option. The covered call play was executed two weeks ago and the stock is currently trading .67 higher than the purchase price. The chart pattern still looks solid and there is no need for an exit strategy. If the stock closes between $34.10 (purchase price) and $34.99 my 30%, 6-week return is secured and additional profit will be earned (but not realized until the stock is sold). If the stock is trading below $34.10 my profit may be reduced depending on the exit strategy situation. If it is trading above $35 per share, I will look at possible rolling out or up and out exit strategies as we approach expiration Friday.
Alan
I just sold calls on these stocks:
ads
arst
med
vprt
cvlt
ej
All are in the money with protection. Made 3.3% in 1 month but will watch for exit strategy chances.
Wishing you all success,
Steve
Really DEEP I-T-M Strikes:
NEU, a stock on my watchlist recently had a positive ER and declared a .25 dividend which yields an industry-leading 1.2%. Trading @$86.13 at the time of this post, a really conservative investor could look down TWO strike prices to the September $80 call. This CC trade would yield a 1-month return of 2% with a downside protection of 7%. In other words, that 2% is protected as long as the stock does not depreciate in value by more than 7% (below $80) by the end of the contract cycle.
Alan
Positive stat for the stock market:
There are a myriad of opinions relating to the short and long term outlook for the stock market. One overlooked, but undeniably important fact is that after the recession began in December of 2007, $160 billion was pulled from the U.S. equities market. Only $27 billion has returned. $94 left the international equity market, while only $13 billion has returned.
Bottom line: There is a ton of cash waiting in the wings to push this market up once the institutional investors are convined that the economy is healthy.
Alan
Check out Lubrizol Corp. (LZ). Nearing a 52-week high. Massive profits with elevated yearly earnings guidance.
You mention that some online discount brokers allow you to place a net debit order, but not your broker. Do you think this type of order is acceptable? This is the only way to place a “buy-write” with my online broker. I recently entered an order of this type. I wanted to buy the stock at 19.30 and the sell the option at 1.10. I had to enter a net debit order of 18.20. The order was filled at 19.32 for the stock and 1.13 on the sale of the option (18.19). I got better than my price, but the individual buy and sell orders executed differently.
Don,
You did well! Your ROO ended up to be 5.8% (113/1932) from an initial request of 5.7% (110/1930). Now you manage any potential exit strategy executions based on these slightly different figures. The only caveat would be to make sure the commission you paid was as low as possible (under $15 in my account for both legs of the transaction).
Nice work!
Alan