Investors employ various strategies in trading, among which are deep in-the-money (ITM) index options. When it comes to executing trades for deep ITM index options, market orders are often blocked. Let’s first understand what these are and then decode why.
Understanding Market Orders
Market orders are commonly used, and often the default choice, by traders to execute trades quickly and at the prevailing market price. These orders prioritise the speed of execution, ensuring that the trade is executed immediately at the best available price in the market. Market orders are particularly beneficial for highly liquid securities where the bid-ask spread is relatively tight, minimising the impact of the execution price.
Open Trading Account and Start Trading!
What Are The Deep ITM Index Options?
Deep ITM index options are options with a strike price that is significantly lower (for call options) or higher (for put options) than the current price of the underlying index. They are characterised by a high delta (nearly 100%), which means they move almost in tandem with their underlying asset. Hence, traders are attracted to deep ITM options for direct exposure to the asset's price movements.
What Are The Risks Associated With Deep ITM Options?
While deep ITM index options offer profit opportunities, they come with certain risks, including:
- Illiquidity: Compared to near or at-the-money options, deep ITM index options usually have lower trading volumes. As a consequence of this illiquidity, there are wider bid-ask spreads. This further results in executing the trades at unfavourable prices, especially when using market orders.
- Slippage: The variance between the trade’s expected execution price and the actual executed price is termed slippage. When using market orders, the same is substantial for deep ITM index options due to their illiquidity. This leads to reduced profits or increased losses.
- Influence on price: When large market orders are executed for deep ITM index options, their market price is manipulated, moving against the trader's favour with increased transaction costs.
Why Are Market Orders For Deep ITM index Options Blocked?
In light of the above-mentioned risks, some brokers block market orders for deep ITM index options. The motive is to protect traders from the adverse effects of market orders. It ensures that they have more control over their execution prices, which reduces the likelihood of executing trades at unfavourable prices.
What Are The Alternatives To Market Orders?
To have better control over your execution prices and reduce the effects of illiquidity, you can employ the following alternative strategies:
- Limit orders - These allow you to specify the maximum price you are willing to pay (for buying) and accept (for selling) for a trade. You can set specific price limits for deep ITM index options and avoid overpaying or receiving less than expected.
- Stop orders - These, in the form of stop-loss and stop-limit orders, can manage risk and protect profits. A stop-loss order automatically executes a market or limit order when the price of the option hits a defined level, thereby restricting potential losses. At the same time, a stop-limit order triggers a limit order when the specified stop price is reached, giving you more control over execution prices.
- Option spreads - Employing option spreads, such as vertical spreads or credit spreads, can also mitigate risks associated with deep ITM options. Spreads involve simultaneously buying and selling options with different strike prices, reducing the impact of bid-ask spreads and enhancing execution efficiency.
Wrapping It Up
Deep in-the-money (ITM) index options offer significant profit exposure but also come with inherent risks that must be carefully managed. Considering the risks associated with deep ITM options, assess whether they align with your investment objectives and risk tolerance. Furthermore, while market orders are typically blocked for deep ITM index options, you can employ alternative strategies to mitigate these risks.
Related Articles: When to use market orders and when to use limit orders | How to Use Limit Orders As Market Orders