How To Buy Options At The Market Open

Don't! That's right, if you decide that you need to purchase options on any index, stock, ETF or whatever, hold off your buying until you see what is happening with the market.

Why?

There are four major factors involved with buying options at the market's opening bell:

1. Oscillation of the market
2. Overnight orders3. Market Makers
4. Open Interest - liquidity - bid/ask spread

We'll talk about each of these in order.

Oscillations - The ups and downs of the markets are difficult to predict. Let's say that you put in an order to buy 10 at the money (ATM) calls on XYZ the night before. That means that your online broker will purchase your calls at the market price at the open of the market.

If something has happened the night before, such as rioting in Egypt, the market will likely correct downwardly in the United States. This happened January 28, 2011. President Hosni Mubarak sent troops and armored cars into Egyptian cities on Friday in an attempt to quell street fighting and mass protests demanding an end to his 30-year rule.

Your broker would have bought your calls for you as your ordered, but you would have taken a substantial loss on your options.

Overnight orders - Your broker has in his queue, many orders to purchase calls on XYZ, in our example. Consequently, with all those buy orders being submitted, the price of your calls will rocket up, only to come down after the flurry of buying has passed - usually at about 10:30 AM or 11:00 AM. You were immediately hurt even if the market continued up later in the day. If the market goes down instead of going up, you are hurt even worse.

I would suggest that you wait until the gush or orders has been filled before you consider purchasing options.

Market makers - Market makers have the job of making a market for options on XYZ. Making a market means that if his asking price is high at the open, your order will be filled, regardless of his asking price.

Let's say that XYZ's call option normally sells for $3.00. In fact, let's say that the last trade the night before, on this option was $3.00. When the market maker sees that he has 1,000 at the market orders for calls on XYZ, he will raise his price for those calls. Perhaps he will offer to sell them for $3.75 each. If you have entered a market order, you will pay the market price of $3.75.

Market makers are very intelligent, crafty, clever and entrepreneurial. Their job is to make the market, and make money doing it. You don't want to trade with the market maker. Similar to Las Vegas, he will always win. You are much better off buying an option with a good open interest.

Open interest - liquidity - bid/ask spread - Open interest is the number of contracts outstanding on XYZ. For example, let us say that XYZ has an open interest on their March 50 Call of 1,000. That means that a number of people own 1,000 contracts they already purchased on XYZ call and currently own it.

Why do you care? It means that people own those particular calls, there might be a certain number of people who are interested in selling their calls. Perhaps they have already made money and want out. Perhaps they changed their mind on the underlying stock. It doesn't matter what his reason is, but he will probably offer to sell it to you for less than the market maker.

To continue our example, the market maker offers to sell the call for $3.75 per contract. If it is 11:00 AM, and the flurry of buying has diminished, the price will probably come back to around $3.00 or slightly higher. This is a highly liquid market, because many people are buying AND selling. If there is a large open interest in that option, you will probably be able to buy it for less than $3.00. You will buy it from someone who wants to sell it for less than the market maker's price.

How do you know? You can check the open interest of a particular option when you pull up the option chain. Look for a column titled OI, OpInt, or Open Interest. Looking at the open interest on QQQQ today, I see that an at the money call has an open interest of 35,831. This would indicate that this is a highly liquid option. The bid/ask spread is $1.33 to $1.36. - Very narrow, indeed.

Let's look at another less liquid example: G (Genpack Limited) shows open interest on their $15, March in the money (ITM) call of 56. There are 56 open contracts already in place. The bid/ask spread on this is $0.80 to $1.25 - a spread of $0.45. Because there are very few people holding this option, you will most likely have to trade with the market maker. He will only sell a contract to you for $1.25. He will only buy a contract from you for $0.45. There are virtually "no other" sellers out there willing to sell their calls to you for less.

So, what did we learn today?

* Don't buy options at market at the market open. The vagaries of the market price and global influences on our market are immense. In fact, this goes for any illiquid stocks, too.
* Don't place overnight orders for options. Wait until at least 10:30 AM before you put in an order to buy or sell options.* Don't deal in a stock or option where you are forced to trade with the market maker. You will always lose.
* Seek out stocks that have high volume. Their options will likely have high volume too. You can check the open interest by looking at the option chain. You want to buy an option that has very high open interest. You will also see that the bid/ask spread is narrow, too.