Methods for placing stops on option trades?

Discussion in 'Options' started by cafemocha, Jan 12, 2010.

  1. cafemocha


    Hi people,
    What method do you use to place stops on your options trades? In my case, I typically trade deep in the money calls with > 80% delta so I am capturing most of the movement of the underlying stock.

    As an example, I buy some calls and I want to set a $2/share stop loss. I am familiar with conditional/contingent orders on ETrade.

    Base the trigger on:

    a) last trade of UNDERLYING stock
    b) LAST TRADE of my calls
    c) BID price of my calls
    d) ASK price of my calls
    e) other

    Sell order for the calls is entered as:

    a) MARKET
    b) LIMIT at my price - $2
    c) STOP at my price - $2
    d) other

    Currently my approach is to use trigger="c" and sell="b". What do you experienced options traders think?

    Thanks for your comments!
  2. 1) Using stop-loss orders with options is a big mistake.

    2) A sudden change in the implied volatility can make a substantial difference in the price of an option - and yes, even when the delta was 80 (it's going to be less whens topped out). You do not want to get stopped out of a trade due to a change in IV.

    3) A world-wide news event may result in a significant widening of the bid ask spread. If the option quote changes from $6 - $6.30 to $4 - $8, you may get stopped out of your position. Do not believe this cannot happen.

    It only take a wide market, or a quote error that lasts for a second or two to trigger your stop loss.

    DO NOT use a stop order based on the option price.

    The ONLY reasonable way to use stop orders on options is based on the last trade price for the stock. Any other choice is unacceptable (unless you love to lose money).

    I hate using market orders, but when using the stock price to trigger the stop-loss order, unless you update your order every day, you will be able to guess what the limit price should be. It changes over time and it changes as IV changes.

    In this situation, you are forced to use a market order.

  3. I would concur with triggering off the underlying's price, which may have to be adjusted daily (or more) for volatility changes.

    As for execution, thinkorswim, for example, has a nice feature which allows you to execute off the bid/ask (or mid) of the option/spread with a plus/minus setting.

    Combining the features, one could sell an option at the bid -0.01 on a limit when the stock went above XX.XX.

    I've used this off and on and it has worked as advertised. However, I only trade the highly liquid ETF/sotck options (SPY, IWM, GE, etc.). Your mileage may vary.
  4. I'm assuming pros would always hedge with the underlying...
  5. drcha


    Yes, I treat them like the stock. On a directional trade, if the underlying has reached a point where I would be selling the underlying if I owned it outright, then I exit the option trade. In other words, if I have decided that I was basically wrong about direction, then I bail.

    As you know, the more often you check these, the more whipsawing you are subject to. Placing a stop loss is like checking them every minute of every day. My method (and this is only one way to do it) is to check my positions once a day. If the thought of only checking once a day produces too much anxiety, then it would mean that I need to be smaller.
  6. Seriously? No stops?

    Chart the option itself and trade based on that.

    Otherwise trade IV as well as the option.

    There is NO REASON why an order is so vague that it needs no stop-loss.

    Fine-tune your trading if that's the case.