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4 Alternative Types of Orders: Market, Market with Protection, Limit

4 Alternative Types of Orders: Market, Market with Protection, Limit

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Turning to market orders with protection, for a while Globex did not permit
classical market orders, such as those we are all familiar with from stock trading.
Now, classical market orders are still not permitted. They have been replaced
by a type of order called market order with protection, which is a classical market
order within price bands.
The precise CME specification is:
Market with Protection Market orders at CME Group are implemented
using a ‘Market with Protection’ approach. Unlike a conventional Market
order, where customers are at risk of having their orders filled at extreme
prices, Market with Protection orders are filled within a predefined range
of prices (the protected range). The protected range is typically the current
best bid or offer, plus or minus 50% of the product’s Non-Reviewable
Trading Range. If any part of the order cannot be filled within the
protected range, the unfilled quantity remains on the book as a Limit order
at the limit of the protected range.
(Reprinted with permission from CME Group Inc., 2014)
This setup is designed to protect the investor against price spikes which,
under a classical market order, could lead to a very unfavorable execution price.
The general idea one gets from the CME literature is that it encourages investors
to specify the price in their orders. That is, to submit limit orders. Limit orders
are simply orders that must be fulfilled at a given limit price or better. That
is, at the highest bid if a sale order or at the lowest offer if a buy order.
The nice thing about market orders is that they get immediately executed
in a liquid stock or a liquid pit traded (e.g. S&P500) futures market. If you
monitor the stock market (by observing the bids and asks) before you trade,
you will probably get pretty close to what you think you are getting, unless
there is a spike in stock prices. If you want some control over the price, then
you will want to submit some kind of limit order.
n

CONCEPT CHECK 1

The following example is adapted from the CME literature (www.cmegroup.
com/confluence/display/EPICSANDBOX/Order+Types+for+Futures+and+
Options; accessed May 27, 2015) and it illustrates how the client interacts with
CME Globex to process a market order with protection bid.

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129

The client sends a buy Market Order to CME Globex ‘Bid 10 ESZ8’. Bid
10 means that the bid is for 10 contracts, ES is the symbol for the E-mini
S&P 500 futures contract, Z represents December delivery, and the 8 refers
to 2008.
At the time the bid was entered, the best offer was 90025 and the number
of Protection Points was 600. This leads to a Protection Price Limit of
90025+600=90625.
a. As a buyer, what do you think this should mean?
The next step is that Globex attempts to fill the order with the following
results:
1. CME Globex sends an Execution Report–Partial Fill 2-Lot @ 90025.
2. CME Globex sends an Execution Report–Partial Fill 3-Lot @ 90300.
3. CME Globex sends an Execution Report–Partial Fill 3-Lot @ 90550.
At this point, there are two remaining unexecuted buy orders. But the market
has moved to the next best offer of 90675.
b. What would happen if the order were an ordinary market order (without protection)?
Unfortunately, the next best offer exceeds the protection price limit of 90625.
c. What do you think happens to the remaining two unexecuted orders?

5.4.2 Limit Orders
Limit orders are a lot more interesting when it comes to futures trading,
particularly electronic trading. There are two types of Limit orders: Limit Bid
(LBid) is a limit order to buy, and Limit Offer (LOff) is a limit order to sell.
Unlike market orders or market orders ‘with protection’ on Globex, limit orders
specify a price.
If you specify an LBid (to buy) at 100, you are requiring that the order
be executed at a price no higher than 100. An LOff (to sell) order of 100 specifies
that the order be executed at a price no lower than 100. Note here that 100
need not be in dollars, but is usually in units in which the contract is
quoted. These could be in terms of an index such as the one used to quote
the S&P 500.

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The downside of limit orders is that they may not be executed immediately,
if at all. If the market price represented by the best bid is below the sell
price in the sell limit order, the sell limit order will not be executed. If the
market price (lowest ask) is above the buy price in the buy limit order, the
limit order will not be executed. Instead, the limit orders go into what is called
the Limit Order Book (LOB). In order to understand electronic trading, an
understanding of the Limit Order Book is essential.
n

CONCEPT CHECK 2

a. Suppose that the market price represented by the best bid is below the sell
price in a sell market order without protection, what would happen?
b. Suppose that the market price represented by the best bid is below the sell
price in a sell market order with protection, what would happen?

5.4.3 The Limit Order Book (LOB)
The limit order book comes into existence because traders submit limit
orders, as opposed to market orders, with specified upper limits for buy orders
and lower limits for sell orders. Unless these limits cross each other, a trade
does not occur and the limit orders go into the limit order book as unexecuted
trades. When new orders are submitted to the market they can ‘pick off’ existing
buy or sell limit orders. These orders would then be executed, and therefore
removed from the limit order book. In brief, the limit order book is the set
of unexecuted limit buy and sell orders available in the market at a given point
in time.
As a stock trading example, suppose that IBM shares are currently trading
at a best bid of $200 per share and a best offer of $204 per share. We assume
that the LOB for IBM is empty. This means that all of the market orders have
already been fulfilled (why?), so that these bids and offers are irrelevant, except
to get a barometer on the recent market price.
You own 100 shares of IBM and you want to sell them for no less than
$205 per share. To do so, you submit a limit sell order, with the specified lowest
limit price at which you are willing to sell. Your order goes into the limit
order book as,
‘100 IBM shares offered at $205/share’

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131

Note that identifiers such as your name would not go into the LOB,
although you would have to provide identifiers and account information in
order to submit the trade.
Another trader, on the other side of the market, wishes to buy IBM, but
not at $204. Instead, he wants to pay at most $195/share. That trader submits
a limit buy order which goes into the Limit Order Book as,
‘100 IBM shares bid at $195/share’
We can now easily construct an elementary LOB by putting the limit buy
order on one line and the limit offer directly above it (see Table 5.3). Sellers
usually want to sell at prices higher than buyers are willing to pay, so this
makes sense.
TABLE 5.3

Simple Limit Order Book (Current Time)

100 IBM shares offered at $205/share
100 IBM shares bid at $195/share

The best limit bid is $195/share and the best limit offer is $205/share so
the limit bid–asked spread is $10 per share. In order for a trade to occur, new
bids and offers have to be submitted.
Suppose that a market order to sell 100 shares enters the market. A market
order says ‘sell at the best available price’, and that is what buyers are willing
to pay, at a maximum. In this case, the best bid is $195/share so the market
order would be immediately executed at $195/share.
If a market order to buy 100 shares is submitted to the market for execution,
it would be executed at the best price at which people are willing to sell. In
this case, at $205/share. The market order would be immediately executed
at this price. If nothing else happened, the LOB would now be empty
because the incoming market orders picked off the existing limit orders.
5.4.4 Depth in the LOB
A real-world LOB is more complex than in this simple example, so the next
thing we want to see is how depth is added to the LOB. At any point in time,
there are numerous individuals independently submitting buy and sell orders
to the market for execution. Many of these orders may be market orders, or

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market orders with protection, which would ‘pick off’ the existing best bid
or best offer as described above, depending on the quantities specified in the
incoming orders.
Let’s focus on incoming limit orders, still thinking in terms of our example.
Suppose that some trader really wants to buy 100 shares of IBM and prefers
not to wait for a better price. Assuming he has access to the standing limit
orders, he sees that the current best offer price is $205 per share. There is no
better offer. To get the 100 shares of IBM, the trader submits a limit order
to buy at $205/per share,
‘100 shares to buy at $205/share’
We know this is a limit order, because market orders do not specify a price.
If the trader’s order is appropriately situated in the queue, his limit buy order
would ‘pick off’ the existing best offer of ‘100 shares to sell at $205/share’.
A trade has just been executed, and therefore is dead to the trading world.
Both limit orders to buy and sell at $205/share have been ‘matched’, creating
a ‘matched (executed) trade’ and would be removed from the LOB because
the LOB consists only of unexecuted limit orders.
n

CONCEPT CHECK 3

It is useful to pursue this example a bit more. Suppose someone submits a
limit order to buy at $210 per share in the above example.
a. At what price would the limit order be executed?
Now we can turn to examine how depth is added to the LOB. As noted,
there could be numerous buy and sell limit orders independently submitted
all at different limit prices from which the highest limit bid and the lowest limit
offer were extracted. This would add both height and depth to the LOB.
An example with the lowest five limit offers and the highest five limit bids
illustrates this (see Table 5.4). Usually, the same number of shares are neither
bid nor offered, and the numbers are not evenly spaced, so this example is
simplified.
Also, once the current highest bid and offer are determined, new orders
enter the market attempting to create an executed trade. What happens to
these orders depends on whether they are market orders, market orders with

FUTURES CONTRACTS: MARKET ORGANIZATION

TABLE 5.4

133

Depth and Height of the LOB (Current Time)

100 IBM shares offered at $209/share
100 IBM shares offered at $208/share
100 IBM shares offered at $207/share
100 IBM shares offered at $206/share
100 IBM shares offered at $205/share (Lowest Offer)
100 IBM shares bid at $195/share (Highest Bid)
100 IBM shares bid at $194/share
100 IBM shares bid at $193/share
100 IBM shares bid at $192/share
100 IBM shares bid at $191/share

protection, or limit orders. Market orders would be immediately executed at
the best available prices.
Limit orders would go into the LOB. Limit orders within the current
bid–asked spread would change the bid–asked spread.
Once again, at any point in time there are numerous traders submitting
numerous limit orders to the market, and they are under no constraint to use
the same limit prices as any other trader. So a trader could very well submit
a limit to buy (sell) order above or below the current best bid (offer) of $195
($205) per share. This would have the effect of changing the bid–asked spread

TABLE 5.5

Trading within the Bid–Asked Spread (at a Later Time)

100 IBM shares offered at $205/share (Old Lowest Offer)
100 IBM shares offered at $204/share
100 IBM shares offered at $203/share
100 IBM shares offered at $202/share
100 IBM shares offered at $201/share (New Lowest Offer)
100 IBM shares bid at $199/share (New Highest Bid)
100 IBM shares bid at $198/share
100 IBM shares bid at $197/share
100 IBM shares bid at $196/share
100 IBM shares bid at $195/share (Old Highest Bid)

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and potential market orders would be executed within the old bid–asked spread
as in the example above (see Table 5.5).
In this example, limit orders get submitted within the bid–asked spread which
is taken to be the prices between $195 and $205 per share as indicated. The
new bid–asked spread becomes $199/$201 per share. New market orders would
be executed at the new best prices available, market sell orders at the best bid
of $199/share and market buy offers at the best offer of $201/share.
5.5 GLOBEX AND THE GLOBEX LOB
Up until now, our examples focused on stock trading. The next example,
illustrated in Table 5.6, involves one of the most heavily traded financial futures
contracts, the E-mini S&P 500. Here is a hypothetical example of the limit
order book from Globex for the Sep 2014 E-mini S&P 500 futures contract
at some time point on May 16, 2014.
TABLE 5.6

Bid Prices

Hypothetical Example 1 of a Globex LOB
Offer Prices
1,868.50
1,868.25
1,868.00
1,867.75
1,867.50
1,867.25
1,867.00
1,866.75
1,866.50

Highest Bid

1,866.25

1,866.00

Lowest Offer

1,865.75
1,865.50
1,865.25
1,865.00
1,864.75
1,864.50

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135

In practice, as limit orders are submitted, that data is entered into the LOB.
The bid (asked) size is the number of contracts in the bid (offer) (see Table
5.7). The price is always a limit price in the bids and offers.
Just as in our stock example, the asks and bids are ‘stacked’ from highest
to lowest. The (highest) bid–(lowest) asked spread is clearly [1866.00,1866.25].
Note that these are not in dollar terms but are in S&P 500 Futures index
points, which we will discuss in Chapter 7, section 7.4. One can translate
these into dollar terms by multiplying by $50 (the current multiplier) for the
E-mini S&P 500. This would give the value of the stock market underlying
one E-mini Sep 2014 S&P 500 futures contract. Based on the best offer, this
amounts to $50×1,866.25=$93,312.50.
The rule for recording of Globex trades is rule 536.B from www.cmegroup.
com/rulebook/CBOT/I/5/5.pdf; accessed May 27, 2015), where we have
excerpted the information:
‘Each Globex terminal operator entering orders into Globex shall input
for each order: a) the user ID assigned him by the Exchange, a clearing
member or other authorized entity and b) the price, quantity, product, expiration month, CTI (customer type indicator) code and account number (except as
provided in Section C.), and, for options, put or call and strike price. The
Globex terminal operator’s user ID must be present on each order entered.
For a Globex terminal operator with access pursuant to Rule 574, clearing
members authorizing such access will be responsible for the Globex
terminal operator’s compliance with this rule.’
(Reprinted by permission of the CME Inc., 2014)
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CONCEPT CHECK 4

The Table 5.7 is built on data for contract ESZ8.cme (the December 2008
delivery E-mini S&P 500 futures contract traded on the CME).
a. Indicate the highest bid and the lowest offer.
b. The number of protection points is 200. What is the highest price at which
a market buy order with protection would be executed?
c. What is the lowest price at which a market sell order with protection would
be executed?
d. Suppose that a market order to buy with protection of 200 points for 200
contracts is submitted. Indicate at what prices it would be executed.

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e. Suppose that a market order to sell with protection of 200 points for 200
contracts is submitted. Indicate at what prices it would be executed.

TABLE 5.7

Bid Size

Hypothetical Example 2 of a Globex LOB
Bid Prices

Offer Prices

Ask Size

832.50
833.25
832.00
831.75

108

830.25

403

830.00

218

829.75

373

829.50

415

829.25

831.50

468

831.25

735

831.00

317

830.75

112

830.50

44

829.00

5.6 PIT TRADING AND THE ORDER FLOW PROCESS
In comparison to electronic trading, open outcry (pit) trading is easy to
explain. Pit trading was effectively eliminated on July 6, 2015 for most, not
all, commodities trading on the CME. It still exists for S&P Futures (and most
futures options), among the most important commodities. Therefore, pit trading
is still worth understanding. That understanding is an introduction to the type
of information transfers needed in order to make electronic trading feasible.
The following schematic in Figure 5.1 describes the basic mechanism for
pit trading, which is age-old. Academics describe it as a double auction open
outcry system to be distinguished from electronic order matching systems like
Globex which we have just described.

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137

FIGURE 5.1 Order Flow Process (Pit Trading)

Buyer submits
purchase order to
FCM

Seller submits sale
order to FCM

Account executives at exchange member
brokerage firms transmit these buy and
sell orders to ‘phone’ persons on the
exchange floor
‘Runners’ deliver orders to traders in the
appropriate pits on the floor of the
exchange. Or they are communicated
electronically
Execution of orders in the pits by open
outcry using a system of hand signals
through which traders communicate with
each other
PIT BID/ASK TRADE
EXECUTED
Floor brokers for each side of the
transaction confirm execution of orders to
member firms. Futures prices on all
executed futures transactions are recorded
for worldwide transmission

Note that we still do not have a valid open futures position because the
clearing house has to intermediate it and assume the opposite side to the buyer
and to the seller. The clearing process begins usually at the end of the day
(now bi-daily) in part to facilitate this intermediation.
Here is the relevant quote from the CME Clearing House Rule Book, Rule
536.A (www.cmegroup.com/rulebook/CBOT/I/5/5.pdf; last accessed May
27, 2015):
General Requirements for Open Outcry Pit Trades
‘At the time of execution, it shall be the duty of every member to record
each trade on an approved electronic device or on pre-printed, sequentially

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pre-numbered trading cards in exact chronological order of execution.
If recorded on trading cards, trades must be recorded on sequential lines
of the card, and no lines may be skipped except that a member may use
additional consecutive lines to record sufficient information concerning a
particular trade type, including, but not limited to, spreads, exchange of
futures or options for related positions and cabinet trades. Any lines that
remain after the last execution recorded on the trading card must be marked
through. No more than nine transactions may be recorded on each trading
card. Every member must record the date, price, quantity, product, expiration
month, opposite trader, time of execution to the nearest minute and, for options,
put or call and strike price on the trading card or into the approved
electronic device. Additionally, the trader must record a symbol which
reflects whether the member was trading i) for his own account or an
account controlled by such member, ii) for the proprietary account of his
clearing member, iii) for another member present on the trading floor or
for an account controlled by such other member, or iv) for any other
account. Trades or order executions must either be recorded on an
approved electronic device, or, if recorded on trading cards in non-erasable
ink. Members using trading cards must use a new card at the start of each
half-hour interval and at the start of the post settlement session.
Members must designate on the trading card whether such trade is a
spread trade.
A member may correct any errors on written trading records by crossing
out erroneous trade information without obliterating or otherwise making
illegible any of the originally recorded information.
The seller or his designated representative (“the seller”) must enter the
trade into the clearing system within 30 minutes of execution. The seller
must enter the material terms of the trade, including the information
required in the first paragraph of this subsection, including the time of
execution. Within 60 minutes of execution, the buyer or his designated representative (“the buyer”) must review the seller’s entry of the
trade and affirmatively note any disagreement with any of the terms of
the trade and enter a time of execution to the nearest minute except in a
circumstance in which the buyer does not know the trade. The seller must
allocate the trade to the correct clearing firm(s) within 30 minutes of the
execution of the trade unless the trade will clear at the seller’s qualifying
clearing member firm. The buyer must allocate the trade to the correct
clearing firm(s) within 60 minutes of the execution of the trade unless the