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What a Combination!! Stock Contingent Options Orders

Episode 150

What a Combination!! Stock Contingent Options Orders

Posted April 12, 2024 at 9:30 am
Jeff Praissman , Dmitry Pargamanik
Interactive Brokers , Market Chameleon

Dmitry Pargamanik, one of the cofounders of Market Chameleon, joins IBKR’s Jeff Praissman to discuss stock contingent option orders. This podcast is a follow up to their insightful webinar, “Stock Contingent Option Trades”.

Corresponding Webinar:

Summary – IBKR Podcasts Ep. 150

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Jeff Praissman 

Hi everyone. Welcome to IBKR podcasts. I’m your host, Jeff Praissman. It’s my pleasure to welcome back to the IBKR podcast studio, Dmitry Pargamanik, one of the co-founders of Market Chameleon.  

Hey Dmitry, how are you? 

Dmitry Pargamanik 

Good. How’s it going, Jeff? Thanks for having me. 

Jeff Praissman 

Oh, my pleasure. And for listeners that are new to the program here at Interactive Brokers, we have a webinar on the second Tuesday of each month with Market Chameleon. And we’re fortunate enough to have Dmitry swing by the IBKR podcast studio after each webinar to further discuss those topics.  

So today, we’re going to talk about stock contingent option orders. And for our listeners, if you missed the webinar, there’ll be links in these viewing notes that you can click and watch the recorded version. Let’s start with the obvious question. What are stock contingent orders? 

Dmitry Pargamanik 

A stock contingent order is a multi-leg order and a lot of people are familiar with multi-legs when they use option multi-legs to do a call spread or put spread or butterfly. And a stock contingent order will involve a stock component to it.  

And what it basically is is just an order that has more than one leg to it and it has to have a stock component. And we’re going to talk about in terms of the other legs as options. Basically a lot of people may not even realize, but when you enter an order or there are a lot of trades out there that are stock contingent, you can place an order to get a fill simultaneously on your option and your stock. And there are a lot of reasons you might want to do that and benefits to enter it in as a contingent order. 

Jeff Praissman 

What are some of the more common examples of this strategy that traders use? 

Dmitry Pargamanik 

The most common strategy I think that people would be familiar with is a covered call or buy-write. And that involves buying stock and selling a call simultaneously. That’s the covered call strategy, unless you own the stock already. If you want to execute it as a covered call, you may enter it and then as the stock end call and that you require that this gets executed simultaneously.  

But there are other reasons you may want to use a stock contingent order. You could use it, for example, creating a conversion and reversal, which you will require a stock component. Or you want to mitigate some of your directional risk and you need the stock component to do that at the time of the trade. So some of those are creating covered calls, maybe synthetics, puts married to stock, covered call or covered put strategy, conversion reversal and so on. 

Jeff Praissman 

And for our listeners that may not be super familiar with these terms, conversion reversal is what exactly, Dmitry? 

Dmitry Pargamanik 

A conversion reversal would be a strategy where you want to isolate your risk exposure to the cost of carry component of an option. So, when you think of options, they have different types of risks associated with them, such as implied volatility, directional and they also have a cost of carry.  

And when you do a conversion reversal, it would be like creating a synthetic long, for example, on a particular strike and simultaneously selling short with stock, right? Or the other way, vice versa.  

And what this will do is hedge away the certain risks that you have regarding an option strategy which would take away the implied volatility. Because you’re buying and selling on the same strike, buying a call or selling a put. Or buying a put and selling a put. So you would take away the directional risk because you’re getting synthetically long with the options then short with the stock. And what you do is you isolate that particular strategy to the cost of carry. And if you, for example, have a different interest rate forecast for going out in time than the market does or maybe you have a different dividend forecast than the market is implying. But also, will have a different opinion of the cost of borrowing the stock. 

 If you had to borrow and sell it short and the fee for that. And to be able to isolate your strategy to that specific cost of carry exposure, you would want to put on a conversion or reversal. And to do that, you would need three legs. You’d need the call and the put on the same strike and the stock. 

Jeff Praissman 

For our listeners, just for those not super familiar with option trading, really what Dmitry’s getting at is that you can create synthetic positions through multiple leg options, whether it’s multiple options or option in stock.  

But they’ll behave in certain ways where they would mimic or be synthetic. For example, buying a put and buying stock is like buying a call, basically. It mimics the same risk and reward graph wise, which is another fascinating subject, Dmitry. And now I’m thinking out loud, maybe a subject for another podcast.  

But there’s definitely plenty of educational materials available on this through our website and Traders Academy, and I would urge our listeners not super familiar, it’s a fascinating subject for a different podcast. For them to look further into these combinations because it really is fascinating.  

So, getting back to our subject Dmitry, why would a trader and investor use this? Like, what are some reasons that they would have the stock attached to the order versus just doing the calls or just buying a call and selling a put?  

What are some of the main uses or the main reasons that someone would want to make it contingent on a stock order? 

Dmitry Pargamanik 

So there could be a number of reasons. So one reason that we see, because we track the trades on the tape and we attach those stock contingent orders to figure out what the likely strategy is.  

But a lot of traders will trade the volatility or the implied volatility of an option. And to do that you would want to hedge away your directional risk. And according to the options pricing model, you’d want to hedge that Delta of the option. So, if you want it to be Delta neutral right from the get-go, and you wanted to say here I’m buying this call, but this call has a Delta, to be Delta neutral, when you initiate the trade, you would need the stock component, right?  

If you wanted to do the stock versus the option and be Delta neutral, you’d want to do it simultaneously. So, for Delta neutral traders, it becomes an important part of the strategy because they want to hedge away or mitigate that directional risk. Now, of course you can just, for example, do the call and then go out afterwards and try to hedge the stock.  

But then what you do is risk that the stock moves away against you and then you end up chasing the stock. So, if you don’t do them simultaneously, if you don’t put it as a contingent order, then you have that additional risk of execution.  

And just from experience, when you need to do a hedge, you’ll always get it when it’s moving against you or if it’s moving away from you, you never get it. So it’s like, you usually want to get your Delta hedge as soon as you put on that option.  

So to be Delta neutral and not have to chase the stock, for example, if you want to do a buy-write and you sell the call, and right after you sell the call if the stock is running and you’re buying stock higher, then you got an inferior price.  

And it also kind of locks in that volatility or implied volatility level that you’re seeking. Because if you’re looking to purchase or sell a certain implied volatility level, by entering that order with a stock contingency, you’re kind of locking that in.  

Because if you do the option and then you get a price in the stock at a worse level, then it’s like buying and selling the implied volatility at a different level. So it’s like locking in that initial implied volatility level. 

Jeff Praissman 

And this makes perfect sense because options are derivatives of the underlying. Clearly a huge part of the price component is based on the underlying price. So it really makes sense whether you’re buying or selling an option or multiple legs. The reference point is a specific stock price. So it makes sense if you are going to do a stock leg to do it as a pair and be able to have it all come in together as one. 

Dmitry Pargamanik 

Exactly. Because if intended strategy is to have that stock component, you kind of then want to try to do it as a pair all simultaneously.  

And I’ve seen customers who’ve told me that before where they try to leg into buy-writes and they would sell the call. And of course, if the stock starts running, you’re buying the stock at a much higher price and now you’re not getting really the prices that you’re seeking in the beginning.  

And the times that well you put in the stock price and then the stock just keeps falling and you would have been better off not doing the stock. This way at least you’re not experiencing those types of issues. 

Jeff Praissman 

And is there a way for people to look at this data? Like is it marked on time in sales or the exchanges? Is there a way for them to see whether or not, say a call traded as a buy-write or whether it just traded by itself? Kind of get that extra level of information regarding the the entire trade. 

Dmitry Pargamanik 

Some of the features that we have is parsing the trade tape and figuring out what’s going on. And as far as the stock contingent rate goes, it does get printed on the tape if the order was entered in as a stock contingent, right?  

So first of all, the order had to get entered in that way if somebody did a buy-write by lagging into it. It wouldn’t be reported and you want to tape that that’s what happened. But if somebody enters in an order as a stop contingent, that means the order was executed with more than one leg and there’s a stock component to it. And there’s an indicator there that this option was stock contingent.  

And then a stock trade itself on the tape also gets reported that this stock trade was contingent. Now there’s no real identifier to tell you which stock contingent trade went with which, for example, options trade or how to stitch these contingent trades together.  

So that becomes a little bit tricky. And what we did was we have a software that basically goes through those trades and stitches together what are the most likely ones that are connected, based on the timestamps and the size of the options trades versus the size of the stock trade and so forth.  

So we try to stitch it together. And you have some information, but information in the financial world, is imperfect. It’s dispersed. It’s not always exact and clear, and there are inferences that you need to make to kind of put the pieces together. The pieces of the puzzle together.  

But yes, we see quite a bit of trading that are stock contingent. We’ve seen large conversion-reversals trading. We’ve seen large, even, spreads that have a stock component to make them Delta neutral. We’ve seen collars, synthetics, covered puts, covered calls. So, people can get unique with them and attaching stock components to their options trades. 

Jeff Praissman 

You kind of talked about this earlier in the podcast, as far as these synthetic positions and how different combinations of options or options in stock can really have a different result or different risk reward than you would initially think.  

So in other words, a call isn’t always bullish and a put isn’t always bearish. Is this something that this data helps give you the full story of the trade? 

Dmitry Pargamanik 

We have lots of customers that look at the trade tape to understand the market. What’s trading or what are people doing? How are people using the options? Are they using the options to, for example, buy or sell implied volatility? Are they using it as spreads? Are they using them perhaps for directional reasons?  

So when we look at an options trade, let’s say a call. And at first it may look like, well, a very large call trade happened here and you could take a couple of inferences there. It could be a bullish trade. It could be because of implied volatility. But if we actually know that there is a stock component to it, to that call trade, for example, it could look like somebody paid the offer. The dealer’s ask price.  

But then we see the stock component in there as well. And that stock component could say, well actually that was a synthetic put.So,o it’s no longer a bullish call. It was actually a synthetic put. A bearish trade.  

Or let’s say we look at that stock contingent trade and we notice that well there’s a big call trade but the stock component equaled out to the delta. Not one for one, but it equaled out to this was a Delta neutral trade. Well now it’s telling us something else. And that’s saying that, in reality, that looked like a trade that was targeting the implied volatility of that option. The implied volatility looked either too low or too high, and they wanted to lock in that implied volatility. Trading it Delta neutral.  

So it could mean a lot of different things when you know there’s a stock component to it and you tie it together. Like we just discussed, instead of a bullish call, it could be actually a synthetic bearish put or it could be just a Delta neutral implied volatility trade. So yeah, knowing these pieces paints a much clearer, better, accurate picture. 

Jeff Praissman 

Yeah. I mean, I feel like a common theme of our podcast is data is just so key to understand. Trading isn’t just throwing a dart at a dartboard and hoping it works out. Like analyzing the data and coming up with thoughtful conclusions is really such a key aspect of trading.  

Any other kind of final thoughts you’d like to leave our listeners with on options and contingent stock orders? 

Dmitry Pargamanik 

Yeah, I think that as far as the contingent orders go, to be aware that these are features and tools that exist. And in certain places it could make you trade more efficiently. It opens up new possibilities that you may have not thought of before, as far as creating synthetics, conversion reversals or we talked about Delta neutral trades.  

And even when you’re looking at the trade tape, and I understand people want to know what’s trading in the market because they want to be informed. Before you enter in the market, you want to know how are people using it? Which way is the order flow going? Where are prices trading?  

And part of that is to know which trades had that stock component because it will make a difference in what the actual strategy was when that particular trade happened.  

I think those are just the final thoughts on the stock contingent trades. 

Jeff Praissman 

Dmitry, thank you so much for coming by. It’s always a pleasure to have you in the studio. 

And for our listeners who want to get more from Market Chameleon, you can click on the study notes to go right to that webinar and take a deeper dive into stock contingent orders. Or go to, click on Education, then on IBKR Campus, select Webinars.  

You can see previously aired or you can go to our contributors and see everything from Market Chameleon or any of our other great contributors.  

And again, thanks for listening. Until next time. I’m Jeff Praissman with Interactive Brokers. 

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