WATCH OUT FOR MISLEADING P&L REPORTS

Profit & Loss Illustration

In a prior article “Where to Trade Options”, I wrote about some of the snags that are involved with option order routing. We touched on the different methods a firm might use when it came to selling a short option position against a covered long option position and how detrimental a firm's procedure can affect the option strategist’s bottom line. The point of the article was to express how much most of these so-called household named brokerage firms do not tell us.

One year, I took on a new client who wanted to trade in his existing account using one of my OPTION STRATEGY MODELS. I advised him that I had no experience trading with his big named firm and it would be a good idea to implement my strategies through a firm we already know is suitable. Instead, he said he would prefer to stick with his current firm since he has been with them for several years. He wanted to check to see if it would be possible for him to stay with his existing firm to execute my option spread strategies.

Several weeks passed and he reached out to me to say that his account was set up for him to begin trading the spread strategies we had set out to do. Although everything seemed okay and he was good to go, I warned him that we should go slowly. Even though we were satisfied with what his firm represented as an acceptable OPTION TRADING PLATFORM, we actually wouldn't know for sure until we started the trading activity. It turns out that the order execution platform used by this household named firm received a C+ but that is not the purpose of this article, instead I discovered another glitch.

As mentioned in a prior article, although we might enjoy several features a firm provides us, there could be one short coming that might irritate us to the point where we will no longer trade through them anymore. The firm my client was associated with had so many bells and whistles attached to their platform. Some of them were a joke and some were very useful. When it came to P&L reporting this particular firm reports the market value of a portfolio by referring to the BID on long positions or the ASK on short positions.

Most of you might say that this is hardly a glitch and one might wonder why I would even call it that. As far as the crowd goes, this is not an issue since there would be a small range between the bid and ask on the type of positions in their portfolio. The value of their positions would not vary too much and it wouldn't matter if the firm uses the BID, ASK or MIDDLE. Example: IBM trading @ 82.50 would have a typical bid of 82.45 x 82.50. In this case with a BID ASK SPREAD of .05 the difference would have very little effect on a P&L report. If one were to own 1000 shares of IBM, the portfolio would show a value of $82,450.00 which is quite true to its real value. The problem here is that this kind of P&L reporting can make a portfolio look like a train wreck when we are involved with positions that have bid and ask spreads of 2.00. Example: in the OEX we deal with bid ask spreads much higher than .05. In a portfolio where an October 600 call is owned, the bid ask can typically be 23.50 x 25.50. So, if one was to own 10 contracts of the October 600 calls with this household named firm, the market value would not be taken from the ASK, it would not be taken from the MIDDLE, it would be taken from the current BID price, even though the option strategist will typically be filled somewhere near the MIDDLE. So therefore, the portfolio value in this firms P&L would be $23,500.00 which is $1,000.00 short of the October 600 calls realistic trading price.

Now, we can see how detrimental this can be to the options traders true P&L. Imagine if one were to have 200 option positions long or short with bid and ask spreads similar to the October 600 calls. The portfolio would in essence show a value of $20,000 less than its true trading value. To further make my point we could buy 10 of the October 600 calls at the middle of the bid and ask @ 24.50. With a firm using the BID/ASK METHOD for the P&L, this position will show $1,000.00 loss seconds after the

trade is filled.

The other point I wanted to make is that if an accurate P&L is a priority (and why shouldn't it be) you would be glad to know that there are firms using the MIDDLE of the bid and ask to obtain the current price of a position. In this case there will be no struggle with misleading P&L reports.