CBOE Rules Related to Investment Orders

Instructor: Byron Yee

Byron has over 5 years of experience in banking and investments and is currently a Candidate for the Chartered Financial Analyst (CFA) Institute. He also is registered with FINRA Series 7 and 66 and has his Life & Disability Insurance producers license for WA state. Previous to his career in banking, he spent 2 years in West Africa as a Peace Corps Volunteer and 4 years in China as an English teacher and financial analyst. Byron double majored in Theatre Arts and Business Administration at Western Washington University. In his free time he enjoys hiking, cycling, running, and being in the great outdoors with his family.

This lesson provides a quick overview of basic options concepts before discussing standardized order information and the two main types of orders for trading options as defined by the Chicago Board Options Exchange.

Protecting an Investment, But With Some Expensive Options

Daniel is interested in buying shares of Stock ABC, but is worried about losing money if the stock price goes down. His broker recommends him to look into purchasing an options contract, which will give him a guaranteed selling price if the stock price does indeed decline. Daniel likes this idea, but thinks that buying these options contracts (which he may not end up using if the stock price does not go down) are too expensive and would like to look for some cheaper alternatives.

Options Overview

We will be covering some basic terms related to options in the following rules, so let's first make sure we are up to speed on some key concepts.

An option is a contract which gives the investor the right, but not obligation, to buy or sell a stock at a set price. This price in the contract is referred to as strike price or exercise price. Options contracts are not valid forever, and have a stated expiration meaning the contract needs to be exercised (to buy or sell at the strike price) on or before the contract expires. A call is the option to buy, while a put is the option to sell stock at the exercise price.

The options contract is a security itself which can be bought or sold on the open market. Most options contracts are traded through the Chicago Board Options Exchange (CBOE). In the following sections, we are going to cover some basic rules about placing options orders in the CBOE exchange system.

Order Information

CBOE has an ordering system called the Consolidated Options Audit Trail System (COATS). This system acts as both a record keeping and monitoring system that collects information on price quotes, orders (a request to buy or sell), and transactions (an actual exchange between a buyer and seller). In order to keep a standardized database of information, CBOE requires each order ticket entered in the system to have the following information.

  • Option symbol: This usually relates to the ticker symbol of the stock in which the contract gives the right to buy or sell.
  • Expiration month and year of the options contract
  • Strike price
  • If the order is to buy or to sell an options contract
  • If the order is a call or a put style options contract
  • Number of contracts: One contract may give the right to buy or sell one stock, so investors usually purchase several contracts so they have the right buy or sell several shares.
  • Clearing member: The clearing member is the organization that executes the trade and helps exchange the money and assets between the buyer and seller.

Now that we have a good idea of what an order looks like, we will discuss the main types of orders below.

Types of Orders

There are two main types of orders for options contracts. The most common is called a market order and this is a simple order to buy or sell a contract at the best price available. For example, you want to buy an options contract for Stock ABC and your broker locates three sellers who want the price $5, $6, and $7 per contract, respectively. The 'best price available' is the investor selling the contract for $5, so this is the one the broker buys.

Let's say you are interested in buying an options contract for Stock ABC, but think that its current price of $5 per share is too high. You are willing to buy if the option contract price goes down to $3, but do not necessarily have the time to check on this price every day. You can make a special order called a limit order, which instructs your broker only to buy the options contract for $3 or less. The order will only be filled if the price drops to $3, or else the limit order will just remain outstanding.

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