No possible to decide stop/loss on options?

Discussion in 'Options' started by mizhael, Feb 23, 2009.

  1. Options are different than other instruments. They can temporarily go down and then eventually come out of water and bring you a profit. This makes deciding stop/loss harder. Even a well constructed trade, with supposedly conservatively small risk/reward ratio, will temporally go down a bit.

    How do you manage such losing positions? Do you enforce strict stop loss policy? How do you decide stop loss point for options?

  2. Stop loss should be on the stock, not the opton. When the underlying is no longer behaving as you anticipate. Or when you change your mind on the outlook for the underlying.

    Problem with all option stop loss orders is finding away to avoid closing the position 'at the market' when the trigger is hit.


  3. The answer is you cant manage stop loss on options alone when market starts to move. I have seen it first hand, when es mini gapped down 30-40pts within 30 mins, market goes crazy and all the es options are basically blank with spread wide enough to drive a mack truck through. If at that point you try to initiate stop loss on the option and close at market, it will destroy your position.

    One way i found was using the underlying to lock in profit/limit loss, because the underlying is still liquid. For example in the ES mini case, if i am short 1x 800P atm contract, es gaps to 750, if i want to initiate stop loss, instead of buying the 800P back at god knows what price, i could go short 1x the underlying at 750. That way my downward loss will be locked. However if the market now reverses back up now you are looking at a unlimited loss on the upside from es short. The idea is to lock in the loss for a very short amount of time until the market stabilizes and you get the bid/ask spread back to normal, then exit the whole position.

    I am not sure if there is any other better way. This is a good topic, if anyone more experienced has better stoploss strategies it be interesting to hear.

  4. Some people use 50% as a hard stop rule. I think it depends on what you expect on a trade. You can use a dollar stop as well. Also, you can look at a volatility based stop system. This is usually applied to the underlying. The issue is when you do decide you are wrong, that is when you should exit. You need to preserve capital when you first start trading.

    $1,000,000 x .02 = $20,000 max loss

    $100,000 x .02 = $2,000 max loss

    $10,000 x .02 = $200 max loss
  5. the problem is you cannot exit with option using stop loss like you do the underlying. For example, if i wrote the atm es 800P for 50 pt, and set the stop loss at 75 pt. When the market gaps to 750, all of sudden you are going to see ask at 200 or some crazy number. If you follow your hard rule of static dollar loss or 50%, you will buyback the 800P at 200 pt not your stop loss of 75pt

    That's actually exactly how IB margin liquidation engine work(it always closes at market), for those unfortunate enough to encounter it