is changing rapidly: Many orders are still executed the old way (floor
execution), with hand signals, screaming, and paper and pencil. As this
style oftrading gives way to faster methods of execution, brokerage firms
can pass along savings by bypassing the staff that is needed to execute
orders in the traditional floor-execution method.
The option exchanges of today are actually hybrids of an open-outcry
system and a fully electronic execution, as with NASDAQ. As far as electronic
execution, the auto-exchange system of the trading floor is fully
automated-involving only the investor and the exchange computer systems.
This system eliminates the need for floor and retail brokers.
Let's walk through the three methods of executing an options orderfrom
the traditional floor execution to the extremely fast fully automated
system.
Floor Execution.
The most common way to trade options is to phone
your broker, who will then send your request to the trading floor (where the
order will be given to a floor broker). A floor broker is an individual who
executes orders on a commission basis on the trading floor ofan exchange.
The floor broker will then announce the order in the trading pit, where the
options on that specific issue trade. Open-outcry bidding for the order
ensues among the market makers who are in the pit. Open outcry is a
method of trading in which the floor broker calls out the specific details of
a buy or sell order so that the information is available to all of the traders
in the trading crowd. Ifyour order is a market order and states that you are
willing to pay (sell) the ask/offer (bid) listed by the market maker, your
order will be executed (traded) right away and the broker will contact your
brokerage firm to notify you. The option contract(s) will then be placed in
your trading account, where you will have an open position (an existing
position that has not yet been closed out). In order to close out the position,
you must either 1) sell the option(s) that you bought, 2) buy back the
option(s) that you sold, or 3) exercise your option(s), thereby converting
your position into a position in the underlying security.
Phone Orders.
Placing phone orders has almost become outdated.
This process generally takes a long time to execute by today's standards
because of all of the individuals who are involved.
Step by step, here is the process:
• The customer calls his or her broker in order to place an order.
• The broker calls the phone clerk on the trading floor.
• The phone clerk hands the order to a runner.
• The runner runs the order to the floor broker.
• The floor broker asks for the market and trades the order.
• The floor broker hands the filled order back to the runner.
• The runner runs the completed order back to the phone clerk.
• The phone clerk calls the retail broker to tell him or her that the
order is filled and at what price.
• The retail broker calls the customer to let him or her know that the
order is filled and at what price.
As you can see, there are many people in the middle (which slows
down the process), and communication becomes important. If anyone in
the chain forgets something or misunderstands something, the order can
be executed incorrectly.
Read More: Options Execution
