TRADING IN OPTIONS
We have already seen that options are traded on exchanges and have already discussed how to understand published quotations. Let us now learn the trading mechanism, that is, the process through which trading takes place on an options' exchange.
Types of Traders
As in stock exchanges, we find different kinds of traders on the floor of the exchange where options are traded. They are market makers, floor brokers and order book officials.
MARKET MAKERS
A trader who trades on his own account in order to make a profit is a market maker. Market makers have an obligation to make market for the investors by standing ready to buy and sell options. Market makers can follow different strategies in the options of the few stocks which he deals in by gauging the mood of the investing public.
FLOOR BROKERS
A floor broker's main job is to execute the order which he receives from outside the exchange at the best possible price quickly. They usually belong to one of the brokerage firms and receive salary or commissions. The brokerage firms also engage in proprietary trading i.e., trading for their own account. Other staff members assist them.
ORDER BOOK OFFICIALS
The order book official is an employee of the exchange who participates in trading. He cannot trade for his own account. His main task is to facilitate the flow of orders. He does so by disclosing the best possible limit orders awaiting execution. He is assisted by other staff members.
SPECIALISTS
These officials function as both dealers and brokers. As dealers, they have to maintain inventory of the stocks they are assigned and deal in them by quoting the prices both ways. As brokers, they have the responsibility of maintaining the limit order book and execute its orders keeping in view the movement in the market prices.
Specialists are employed by the American Stock Exchange, but in Chicago Board Options Exchange, the function of the specialists is divided between market makers and order book officials.
Types of Positions
Options trade fall into one of the four categories:
- Open a position with a purchase
- Open a position with a sale
- Close a position with a purchase
- Close a position with a sale.