How does exchange match multi-leg option orders?

Question

Suppose I submit an order to open an iron condor or some other multi-leg stock option spread with multiple buys and sells.

For example, if SPY is trading at 275, I might want to:

• sell a call at 290
• buy a call at 295
• sell a put at 260
• buy a put at 255

...while specifying a limit price of $1 for the entire position.

When I submit this order, does the broker matching algorithm only look to find an opposite order that exactly matches my order? Or is the algorithm smart enough to fill the call spread and the put spread separately for a combined credit of $1? How exactly does this work?

The only explanations I have seen regarding order fills are for single legs where the matching algorithm is pretty simple and easily understood.

Answer 1

The broker has nothing to do with the actual filling of your order. He is merely the intermediary between you and the option exchange (unless the broker is a market maker in your underlying).

Whatever algoritm the exchange is using is not going to fill one vertical spread and then look to fill the other side. That's legging in and has market risk, possibly resulting in only a partial fill.

I can't offer much regarding the mechanics of a fill on the exchanges. It involves tools like the execution management systems (EMS) which scans complex order books across multiple exchanges as well as other tools (see link) which I could not explain since as a trader, I'm only interested in a fill at my price. How they get there is immaterial to me :->)

Answer 2

Many of the US options exchanges now offer a 'complex order book' in which combinations of options can be listed as a new security intra-day. Once the 'instrument' is listed, a bid or offer can be placed in this security.

Depending on the exchange, they may synthesize prices of the opposing side based on the prices of the individual legs in their order book.

If the price of your order matches the other side, a trade takes place, either from another participant or market maker, or from the exchange matching individual legs from their book from other market participants.

This way the exchange ensures that the order will be filled completely.

Brokers may also offer the capability to purchase the combination of legs from multiple exchanges, but typically they state that this is done on a 'best effort' basis, meaning that they might not get all of the legs.