The ins and outs of debits & credits

Notes on debit & credit orders.

Tutorial: Debit and credit orders are combination orders used to simultaneously buy or sell different security types (e.g stocks and options), where you don't care about the prices you pay/receive on the individual securities, just so long as the total is equal or better for you than the amount you specify.

These are useful for several reasons:

1. You remove the risk that the stock will move against you between the time you put the 1st position in place until you can get the second in place
   
   
2. Often you drop into some internal sanctum of brokers where the pricing rules that mere mortals have to adhere to are missing. For mortals you can't go below 1 cent increments on your stock price, or 0.05 for options below $3, and 0.10 on option prices above $3. With a debit or credit order you will sometimes see your stock price go to 3 decimals (e.g. 127.238) and the options down to the penny
   
   
3. With these orders you are in a much better position to try and beat the "spread" between the bid (what the market maker will buy your stuff for) and the ask, which is what the market maker will sell the security to you for. When the stock is jumping around on a busy day it is scary to make an offer between the bid/ask because you might miss out if the security moves the wrong way. Even tougher, if the bid / ask on an option is only a tenth for a option above $3 (e.g. 4.1 bid / 4.2 ask), you can't even submit an order that splits the spread.
   
   To keep debit and credit straight, my mnemonic is : debit -- me going into debt, credit -- me getting the credit. I use debit orders for doing a buy/write (buying stock and selling covered calls) or credit orders for closing them out. Don't try to use "market" combination orders, these aren't handled automatically in some cases and can take a significantly longer period of time for one half to execute -- which defeats the whole purpose of the debit/credit order.

• I had several recent debit orders execute quickly -- which implies I was leaving money on the table (or in one case I was just being stupid). The coarseness of the option pricing vs the underlying typically adds 0.1 of slop in the pricing (on options above $3 anyway)--so that needs to be factored into your bid plus at least splitting the bid-asked spread.
  
  It isn't hard to change the order, so I'm thinking I should start at 2/3rds of the spread + the slop factor should be the starting point. For example, for a buy/write: if the underlying is at $54.35, the $47.5 calls at 6.90 bid, 7.10 asked (0.05 of premium on the bid price) . Then, the slop is .05 at this point (the option probably won't go to 7.o bid, 7.2 unless the stock reaches $54.40 ). The spread is 0.2, so 2/3rds of that is 0.13. So a reasonable starting debit offer for a buy/write would be: 47.5-(0.05 premium already in bid price+ 0.05 slop + 0.13 bid/ask split) = $47.27. This is an offer designed not to leave much money on the table, but not wasting your time with a no-go offer.
  
  
• In some cases debit /credit orders don't work well at all. If you order is split up and each part goes to a different exchange, then the tight time coordination and ability to beat the spread is lost. If you see stock / option pricing go by that should have triggered your order, but didn't, this is probably what happened. You should cancel and drop back to manual control at that point.