OK...I've begun moving into options trading from equities and have a question about using stop loss orders on options. (I use them every trade w/equities). How are you managing stops on options? Seems like options (at least the 1-2 month til expiration type) can swing 10-40% in a day; how the heck would I place a meaningful stop in that situation? I think I'd be stopped out of 80% of the trades i initiatied. What about identifying a stop loss point on the underlying itself, triggering the sale of the option if it's reached? I have let a few recent small losses on options turn into large losses and need to develop a better stop strategy right now. Thanks for any thoughts on this.
Usually, I will not place stop orders on any options trades primarily due to the swings you mentioned and liquidity. When I do actually place stop orders I will use conditional orders with the conditions based on the underlying. Since I am trading on the movement of the underlying (and IV), it only makes sense to decide when to get out based on the underlying action.
That is the risk in outright speculation with options. The leverage can work for you or against you. Try trading only options that have enough liquidity that they normally have penny spreads. If your strategy is to identify a setup in the underlying, and then try to leverage potential movement with options, then you are going to be stuck using options with less liquidity and wider spreads. That translates into larger percent losses when you're wrong about movement in the underlying. I've said this before, but the largest impact on the price of an option is the absolute level of the underlying. IV is of secondary importance. If you're not good at predicting short term movements in the underlying, you shouldn't be speculating with outright options positions. Perhaps switch to a hedging strategy.
I use Thinkorswim, and they let us place conditional orders on options. For example, (sell to close) MSFT Apr 30 call, if MSFT is at or below $28.00. So check with your brokerage firm.
it depends on the option, unless it has tight bid/ask, placing stops is sometimes more risky than not. Some methods i tried in the past including placing stop on the underlying price level (which usually is much more liquid and doesnt swing like a wild monkey) and have that trigger the option buy/sell. Or if selling/buying options with closer itm strikes/higher premium, put a stop on the total amount of credit/debt lost before closing the position instead of stop on the actual option price level. To be honest none of them worked too good, now i just always have at least a delta hedge in place, then just have it send alerts to my smartphone whenever the underlying movement exceeded certain trigger. I can then log onto the trade screen from my smartphone to decide whether or not to close the position.
thanks for the replies. i agree with the assessments; also the other reason i have been hesitant to use stops is that even if the underlying increases/decreases to your stop point, you still have to sell/buy back the option. so for instance your stop would be like: "if ABCD stock decreases to 52.00, then sell APR 50 ABCD CALL at market". the problem is that selling an option at "market" can get you screwed, accepting a much lower price then a limit order. and i don't think you could specify a limit, becuase you have no idea of the spreads or price levels of the options in the future.
If you are being stopped on 80% of your trades, either your strategy is wrong, or you are using options with too few time until expiration. You can buy 1 share of the option' undelying index or ETF, and place a stop loss on the stock. Then you place a "One triggers other" order, so that if the stock is stopped, your options are sold.