If you have been following my blog for any length of time, you know I am a fan of day-trading delta 7 or higher options on big, popular high-priced stocks. And a key part of this strategy is to limit losses to $100 or 1 point when trading a single lot. These are pretty tight parameters for an option trade since a delta 0.7 option will move 70 cents for each $1 move in the underlying. This means that a move of about $1.30 in underlying will cause a stop-out in this type of position. And that's nothing for a high priced stock such as GOOG or AAPL.
Add on top of that the fact that the bid-ask spread for these options can be 1 point or more, and its easy to see how this strategy can make me easy meat for the market makers. That said, I have had a pretty decent record thus far and my $1 stop loss has resulted in a loss of at most $130 or $150 on a 1 point stop.
Well all that changed this past Tuesday when was trading the GOOG 895 call which I entered on Tuesday at 18 with a target of 20.5 and a stop-loss of 17. I watched the stock shortly after entry and at one point I was up about 1.2 or $120 or so within a few minutes. At this point, there was nothing left to do but just sit back and let the trade play out. GOOG had briefly tagged $920 on Monday and I figured a retest could be in the cards.
A few minutes later, GOOG pulled back to just about break-even, then gapped down about $2.2 or $2.5 points. At first, it seemed like a bad tick, and the options did not immediately follow. Instead, they sort of froze and waiting to see if the price in the underlying were just a bad tick or what. I expected the options to catch up within a few seconds, but instead they just froze. And I sat there watching the price bounce around, have traded well below my stop price yet the option prices were not updating, nor was I stopped out of my position.
Now this is the type of moment when time just stops as a trader. You are in a position, and you have a stop, but the market is not letting you out. And it moments like this when you hearken back to the all the fine print in the account agreement when you sign off on the fact that you can incur financial losses based on failures in technology, servers, the Internet, bla, bla bla. I get all that, but the market maker has an obligation to maintain a fair and orderly market on the underlying if its trading right?
Well all this went on for 2 or 3 minutes but seemed like an eternity. Tradstation continued to update quotes, but a slower pace than usual. Its hard to say whether the slowness was real or imagined, but it seemed clear that either the market makers were not updating their quotes, or the Tradestation stop server was hung. Some time after that, the options caught up, and I was stopped out at $15.70, a full 2.3 points instead of the 1.0 point stop I planned upon.
At this point it occurred to me that stops are just a promise, and promises are not always kept. It's not that we can't trust the Options Clearing Corporation. Its more that the options market maker can cease to make a market at any time based on their inability to price the underlying. And this could happen in a a flash-crash or other adverse market situation. It could also happen if trading in the underlying is halted based on news pending or any number of other unexpected events. It doesn't happen often, but its part of doing business in the wild world of financial markets.
All this makes the case for doing a more time-based methods of trading such as credit spreads, condors and other trades which benefit from Theta decay. I have come a long way in my journey as a trader, but in many ways, I'm just getting started.
Enjoy your weekend and get some rest.