Stop-Loss in Options Trading

D

dragonman

I wondered if anybody here uses stop-loss orders in his options trading and if so how do you decide to place it.

I can understand the reason for stop-loss orders in stocks trading but I assume that stop-loss orders in options trading may be futile, since an option is a leveraged instrument that its price can be changed by large percentages within only a few hours, so that any stop order can be arbitrary triggered due to random price movements or other changes in the Greeks. Therefore it is important to plan the trade in advance, and to make certain adjustments if necessary, but not to place such an automatic stop-loss order.

Also, the option itself may include some kind of stop-loss. For example, if instead of buying a stock for $1000 and placing a stop loss at 10% below the purchase price I bought a call option on this stock for $100 through which I "control" the same $1000 equity, isn't it some kind of a "built-in" stop-loss?

Any feedback will be appreciated.
 
I don't know if it's helpful to you since it's not stop loss info...

I set and reset price alerts throughout the day on the options and the UL. Sometimes, due to muliple option positions, I do the same on the P&L in a DDE connected spreadsheet. These price points may be for closing an existing position or opening a new position as well (adjustment).

Here's an example. There are very few stocks that I'm willing to own but once in awhile I get one due to assignment which I'll then write slightly OTM covered calls on. More often than not, I probably convert to a collar, especially if the UL bounces, buying cheaper puts. Now, rather than sit on it until expiration, I'll reverse adjust the CC component as the UL fluctuates.

Most people tend to roll their calls down as the UL drops trying to stem the losses. In this situation, I might roll the call up a strike or two when it drops a pt or two and if I get a bounce, roll it down if/when it rises ($1 strike intervals). If I'm lucky, I get some call trading gains during the month. If not, I'm just a CC (or collar) holder waiting for expiry.

Obviously you net more if you write a higher strike, do nothing and get taken out at expiry. But who knows if that's going to happen? Rolling intra-expiry gets you income now and that's gravy if the UL doesn't hit that higher strike.

To the downside, if the UL breaks through collar's put strike, I'm likely to roll the puts down a strike $1 lower, booking the ITM gain. Chances are, I might slightly increase the number of long puts at the lower stike if the UL is cracking, since more long puts soften the blow better. If it reverses, that booked ITM put gain isn't lost.

Doing any of this does not guarantee a profit but it does guarantee that no equity position will get a major hammering and that's first and foremost for me. If/when the UL eventually cooperates, a net profit will be booked (options traded intra-month plus the exercise).

Sorry for the novella. The point is that price alerts are essential to me for managing such a position and they're placed in the vicinity of where I think I might be taking action. When they fire, I either execute. If not, I reset until price is acceptable then wash, rinse, repeat as often as the UL allows.
 
When I am trading calls or puts in place of getting long or short of the underlying I use the same stops I would use for the underlying. I set conditional orders to exit the option based on the price of the underlying. As per money management and position sizing, I round down my options positions by one contract relative to how I would position size 100 share lots in the underlying, and doing that usually more than absorbs any issues I may have with theta or vega at my stop.
 
Quote from spindr0:

I don't know if it's helpful to you since it's not stop loss info...

I set and reset price alerts throughout the day on the options and the UL. Sometimes, due to muliple option positions, I do the same on the P&L in a DDE connected spreadsheet. These price points may be for closing an existing position or opening a new position as well (adjustment).

Here's an example. There are very few stocks that I'm willing to own but once in awhile I get one due to assignment which I'll then write slightly OTM covered calls on. More often than not, I probably convert to a collar, especially if the UL bounces, buying cheaper puts. Now, rather than sit on it until expiration, I'll reverse adjust the CC component as the UL fluctuates.

Most people tend to roll their calls down as the UL drops trying to stem the losses. In this situation, I might roll the call up a strike or two when it drops a pt or two and if I get a bounce, roll it down if/when it rises ($1 strike intervals). If I'm lucky, I get some call trading gains during the month. If not, I'm just a CC (or collar) holder waiting for expiry.

Obviously you net more if you write a higher strike, do nothing and get taken out at expiry. But who knows if that's going to happen? Rolling intra-expiry gets you income now and that's gravy if the UL doesn't hit that higher strike.

To the downside, if the UL breaks through collar's put strike, I'm likely to roll the puts down a strike $1 lower, booking the ITM gain. Chances are, I might slightly increase the number of long puts at the lower stike if the UL is cracking, since more long puts soften the blow better. If it reverses, that booked ITM put gain isn't lost.

Doing any of this does not guarantee a profit but it does guarantee that no equity position will get a major hammering and that's first and foremost for me. If/when the UL eventually cooperates, a net profit will be booked (options traded intra-month plus the exercise).

Sorry for the novella. The point is that price alerts are essential to me for managing such a position and they're placed in the vicinity of where I think I might be taking action. When they fire, I either execute. If not, I reset until price is acceptable then wash, rinse, repeat as often as the UL allows.
More...

Thanks for the explanation, very interesting. I assume that you create collars only if the UL goes up so that you are able to buy cheap puts at the price that you would place a stop-loss order on the stock and you are not creating an upfront collar position (and thereby limiting your proft potential substantially) right?

Also, when you create the collar only when the UL goes up (by buying cheap puts) don't you think that the put buying substantially reduces you profit potential as opposed to a strategy without any puts? Is it worthwhile?
 
Quote from HustleThePlanet:

When I am trading calls or puts in place of getting long or short of the underlying I use the same stops I would use for the underlying. I set conditional orders to exit the option based on the price of the underlying. As per money management and position sizing, I round down my options positions by one contract relative to how I would position size 100 share lots in the underlying, and doing that usually more than absorbs any issues I may have with theta or vega at my stop.
More...

are your conditional orders mkt or limit? e.g. if spy hits 126 sell jan 126 call but if it's a mkt order you could get screwed esp w/ illiquid options.
 
Quote from dragonman:

Thanks for the explanation, very interesting. I assume that you create collars only if the UL goes up so that you are able to buy cheap puts at the price that you would place a stop-loss order on the stock and you are not creating an upfront collar position (and thereby limiting your proft potential substantially) right?

Also, when you create the collar only when the UL goes up (by buying cheap puts) don't you think that the put buying substantially reduces you profit potential as opposed to a strategy without any puts? Is it worthwhile?
More...
Sometimes the long puts are already in place since the initial position was a vertical. It finishes just ITM so the collar occurs by adding the short calls.

All hedging reduces profit. If you can get the direction of the UL correct most of the time, practice disciplined money management and never be whacked by a gap, hedging is a waste of time. I have only figured out the money management part so I'll always accept a modest gain or small loss when totally wrong. Riding a stock down 5-10 or more pts down w/o protection is against my religion.

I'm also not averse to scalping the collar's UL intraday and restoring the collar by day's end.
 
Quote from FrankSlaughtery:

are your conditional orders mkt or limit? e.g. if spy hits 126 sell jan 126 call but if it's a mkt order you could get screwed esp w/ illiquid options.
More...

Market, but I only trade in the most actively traded penny increment spread atm options. The atm spreads are almost always one cent, or two at the most. You've really got to get several points out before you see a spread of even three to five cents. I also buy slightly in the money, picking my strikes based on my stops. So should a stop be hit based on the underlying, I am exiting whichever contract is atm at that time.
 
I have tried stop loss orders both based on the option price and on the underlying instrument's price. I have had poor results with both.

With regard to tying the stop loss to the option price, if the bid ask moves just a little, the stop loss can be triggered without any real change in the stock.

Tying the stop loss to the underlying exposed me to changes in volatility, and market conditions so that the move in the underlying was greatly magnified before the stop loss order was executed.

I stopped using stop loss orders, and now I hedge my options positions with either a vertical or horizontal spread (sometimes a diagonal spread). I also found it helpful to consider how to roll out a position or otherwise adjust it depending on the market move.

Depending on the circumstances, I sometimes enter into what I consider a binary trade. For example, let's say I want to call a market bottom. (Side note-don't do this). I would enter into a credit spread that pays $8.50 on a $10.00 spread. Thus, my maximum loss is $1.50, but I need the underlying to move sharply to capture the the full $8.50. In this situation, a stop loss does not make sense -- you are all in, so to speak. Adjustments can be made, but they tend to make the trade even more unlikely.

Of course, we talk about options as if they are all the same. But buying a DITM call is totally different from selling an OTM call in the front month. Some specificity about what you are buying might help focus the discussion.
 
Quote from roreilly:

I have tried stop loss orders both based on the option price and on the underlying instrument's price. I have had poor results with both.

With regard to tying the stop loss to the option price, if the bid ask moves just a little, the stop loss can be triggered without any real change in the stock.

Tying the stop loss to the underlying exposed me to changes in volatility, and market conditions so that the move in the underlying was greatly magnified before the stop loss order was executed.

I stopped using stop loss orders, and now I hedge my options positions with either a vertical or horizontal spread (sometimes a diagonal spread). I also found it helpful to consider how to roll out a position or otherwise adjust it depending on the market move.

Depending on the circumstances, I sometimes enter into what I consider a binary trade. For example, let's say I want to call a market bottom. (Side note-don't do this). I would enter into a credit spread that pays $8.50 on a $10.00 spread. Thus, my maximum loss is $1.50, but I need the underlying to move sharply to capture the the full $8.50. In this situation, a stop loss does not make sense -- you are all in, so to speak. Adjustments can be made, but they tend to make the trade even more unlikely.

Of course, we talk about options as if they are all the same. But buying a DITM call is totally different from selling an OTM call in the front month. Some specificity about what you are buying might help focus the discussion.
More...

Mr. Reilly, what are you trading in that gives an $8.50 credit on a $10 spread? Thanks.
 
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