We’ve all had it happen: A buy order placed after the closing bell blows up in your face and you awake to find the option premium has skyrocketed overnight. How does such significant movement happen?
Isn’t the market supposed to be closed? Yes and no.
For many years, only big institutional buyers had access to the trade after the closing bell rang at 4 p.m. Eastern. Then, in 1999, individual investors were given access, as well, a move that was made far easier by the advent of electronic communication networks (ECNs).
The ECNs are applications that act as agents, offering a place where buyers and sellers can display and match their orders 24 hours a day. The ECNs don’t actually make trades themselves, but they receive a fee for every transaction. Interestingly, while anyone on the ECN could see transactions that individual stock investors make, big institutional investors can trade anonymously, thus concealing their actions.
It can be frustrating as market makers are shifting billions of dollars out of everyone’s view. They also have an advantage because many firms report earnings or other significant items overnight, so after-hours traders can act on the news before you’ve even had your first cup of coffee.
Knowing this, many individual investors are tempted to foray into the after-hours dimension, but that bears a lot of risk. Decreased liquidity is chief among them because there are many more players during regular hours, so the after market likely means less trading volume for your stock and more difficulty converting shares to cash. Less trading volume also goes with increased volatility, so watch out for wild price fluctuations.
There’s also a chance for wider spreads between bid and ask prices, so it may be hard for you to get your order completed at a good price. That’s partly because, as an individual investor, you’re competing against large institutional! investo rs who have more capital than you.
It’s my stance to leave after-hours trading to the big dogs, but there are a few things that could help ensure get into your intended trades at a reasonable price.
First, a proposed solution has been an extension of trading hours, but since that’s likely a long way off, using limit orders can help significantly in the meantime. A limit order is an order to buy or sell a security at a specific price. Using them will ensure that if you place a buy order for a trade after 4 p.m. Eastern for an option at $1, if market makers do their voodoo overnight, you won’t get stuck buying the position if the option runs to $4 by the morning.
The next important rule is: Don’t chase an option. If a premium runs up a nickel above our Buy Under price, an option may still be a good play, but anything over a dime above what we recommend shouldn’t be pursued because it will impact the option’s profit/loss picture.
If an option’s price runs up and comes back in a day or two, it’s generally still OK to get in. But, if it doesn’t pull back in two days, it’s probably not worth waiting for. If you put more on the table than is recommended, there’s more of your capital to lose if all the hype is already out of the trade. Even if the trade still goes up a little bit, it’s likely not worth it if it’s barely covering your commission costs. The third rule is: Know thyself. There are basically two kinds of options traders. The ones who are happy to bank a successive series of small profits, perhaps 50% or so, then they cash in and move on.
Then there are those who want those 400% gains, like my subscribers saw in a Cypress Semiconductor (CY) trade.
There’s nothing wrong with either option trading strategy, and sometimes you’ve got to do both, but no matter how quickly options are trading, you need some element of either watching the circulars for a sale price or putting in a goo! d-till-c anceled order (GTC) and maybe counting your blessings if “everyone” got in before you did.
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