Stops?

[Neoxx]

Working in a litigious industry, and having witnessed some spectacular mistakes, I'm a keen proponent of risk management. So although I'm new to trading, it feels natural to extend the concepts.

Being a swing trader out of necessity - working long hours (GMT) and with other commitments - while I can review all my open positions on a daily basis, I can't monitor them closely.

I have no particular attachment to the capital in my trading account, all of which I can afford to lose, but I'm fairly risk averse.

I don't want to lose more than 1% of my total account value if a trade goes against me.


I have 2 questions, (mostly concerning ITM/ATM call options)-

1) What's the best way to implement stops with options?

Spend 2% on a position, then place a stop loss order for when the BID price has dropped to 50% of the initial ASK price?

Place conditional sell orders, based on the underlying equity and it's support level?

2) After a nice move, to protect profits, should I simply tighten the stop or place a trailing stop, and how would that work with options?

(long the GLG JAN 25 Call, and the AEM FEB 20 Call since 22nd December)

Many thanks,
Neoxx

P.S. I use the IB interface, so if someone is familiar with the actual mechanics of doing this, again I'd be grateful for some advice

 

[Cache Landing]

I don't use IB, but I can give you some opinion on your questions. I would first offer a word of caution with options. They are more illiquid than the underlying and therefore your stop could be missed as a result of a big move in the underlying. Trailing stops help to solve this a little bit, but you are still vulnerable to overnight gaps. But then, from experience, I also stay away from anticipated big events such as earnings announcements.

If you are only willing to lose 1% on a trade then you are absolutely going to need to limit the amount that you commit to a particular position. This being the case, your bank roll will need to be a bit larger than many of the options traders you will encounter. If the 2% that you would allocate to any given trade is small, then a lot of your profits will be eaten up in commissions.

Well, I digress. You mentioned that you lean towards ITM or ATM. Higher priced ITM options would allow you to allocate a larger percentage of your capital to a position and set a stop, only allowing 1% loss of account value.

In regards to conditional sell orders based on the underlying. I would be careful with this strategy. Options traders have to worry about implied volatility. It happens frequently that although the price of the underlyng might not change much, the options price can crash in a hurry. You also have to worry about time decay for shorter term options. In both of these cases you could lose you entire position even though the underlying has not gone against you. Unless of course you are ITM to begin with, in which case you would be left with the intrinsic value. I do use this method though, as the strategy I play is based very much on support and resistence of the underlying.

After a nice move, I would recommend trailing stops, which again can be based on the option price, or underlying.

One question though, being slightly risk averse, did you ever consider integrating vertical spreads into your strategy. They can be used to enhance overall return of a position in the underlying as well as allowing for a more aggressive strategy with more limited risk.

 

[thenewguy]

I'm still fairly new to options, but this makes the most sense to me:

Quote from Cache Landing:

One question though, being slightly risk averse, did you ever consider integrating vertical spreads into your strategy. They can be used to enhance overall return of a position in the underlying as well as allowing for a more aggressive strategy with more limited risk.

The two biggest strengths of options (imho) are their versitility and leverage over equities. Obviously leverage is a double-edged sword and can cut both ways, but structuring risk adverse strategies is one of it's strong points. In my opinion, a spread of sorts is better than a stop loss because they can be designed to protect your position against different types of risk (vega, theta, gamma etc) rather than just price movement like stops do.

But again, I'm just learning this stuff....

- The New Guy

Quote from Neoxx:

Working in a litigious industry, and having witnessed some spectacular mistakes, I'm a keen proponent of risk management. So although I'm new to trading, it feels natural to extend the concepts.

Being a swing trader out of necessity - working long hours (GMT) and with other commitments - while I can review all my open positions on a daily basis, I can't monitor them closely.

I have no particular attachment to the capital in my trading account, all of which I can afford to lose, but I'm fairly risk averse.

I don't want to lose more than 1% of my total account value if a trade goes against me.


I have 2 questions, (mostly concerning ITM/ATM call options)-

1) What's the best way to implement stops with options?

Spend 2% on a position, then place a stop loss order for when the BID price has dropped to 50% of the initial ASK price?

Place conditional sell orders, based on the underlying equity and it's support level?

2) After a nice move, to protect profits, should I simply tighten the stop or place a trailing stop, and how would that work with options?

(long the GLG JAN 25 Call, and the AEM FEB 20 Call since 22nd December)

Many thanks,
Neoxx

P.S. I use the IB interface, so if someone is familiar with the actual mechanics of doing this, again I'd be grateful for some advice

 

[Cache Landing]

After quite a few big losses and a number of different strategies over the years, I settled into using mainly vertical spreads. There are many reasons for this, but some simple advantages of spreads are:
-built in stop loss that can't be hurt by a gapping equity.
-very defined P/L ratios.
-the ability to profit from time decay without unlimited risk.
-if done correctly an increased probability of profit.

Of course, I have a little different view on risk. There is theoretical risk and probable risk. With any option strategy there is the possibility that you could lose 100% of the money at risk. But that is also a possibility with trading the underlying too. It just happens faster with options. As do the gains (if you play them right).

What I like about verticals is that when the underlying goes against you, the damage is done much more slowly. Then once you've decided that enough damage has been done, it is very easy to buy back the short leg and let the long leg run on a day that the underlying has directional momentum. The other nice thing is that the further the underlying goes against you, due to the changing delta, the easier it is to eliminate losses, or even turn losses into profits.

Sorry, I don't want to change the topic of this thread. Just thought I would give you a peak into my chaotic brain. Something to think about when you define your risk tolerance.

 

[Neoxx]

Hi,

Thanks for all the advice. Much appreciated.

I started out with mostly ATM calls, and learnt the effects of theta and vega the hard way. Fortunately, I started with a paltry-sized account and practiced good risk management so my lessons were cheap.

The reason I've decided to go more with ITM options now (delta 75-80) is so they simulate a leveraged stock position, while minimising vega, theta and gamma. At least that is my understanding. And I plan to limit my investment in any one position to 10% and my loss to 1%, based on the underlying support.

In regards to conditional sell orders based on the underlying. I would be careful with this strategy..... I do use this method though, as the strategy I play is based very much on support and resistence of the underlying.

Like you, S/R levels are crucial to my entry and exit. In fact, all I'm using are the price action, 50/200 SMA, volume and candlesticks.

How far below support do you recommend placing the sell stop?

After a nice move, I would recommend trailing stops, which again can be based on the option price, or underlying.

How much room do you give your trailing stop?

When would you convert this to a tight stop?

At the moment I'm just trading single contracts. Once the numbers rise, any ideas for scaling out profitably?

One question though, being slightly risk averse, did you ever consider integrating vertical spreads into your strategy. They can be used to enhance overall return of a position in the underlying as well as allowing for a more aggressive strategy with more limited risk.

The two biggest strengths of options (imho) are their versitility and leverage over equities. Obviously leverage is a double-edged sword and can cut both ways, but structuring risk adverse strategies is one of it's strong points. In my opinion, a spread of sorts is better than a stop loss because they can be designed to protect your position against different types of risk (vega, theta, gamma etc) rather than just price movement like stops do.

I agree completely. The versatility is attractive and the complexity absorbing. Spreads are one of the strategies I definitely plan on implementing, especially calendar spreads.

However, as I said, I'm still new to all this, so have decided to keep the option component relatively stable and simple while I improve my risk management, technical analysis, and fine-tune my strategies.

Also, I'd rather work without too much of a safety net to begin with, so I can start developing some iron-clad discipline.

I want to see how comfortably I can cut my losses and how confidently I can let my winners run.

 

[Neoxx]

If the 2% that you would allocate to any given trade is small, then a lot of your profits will be eaten up in commissions.

One of the reasons I moved over to IB was their great comissions. 75 cents per option contract. Like a mosquito taking a bite of your cake.

 

[cnms2]

Lately commissions became so small that they're negligible compared to slippage.

Quote from Neoxx:

One of the reasons I moved over to IB was their great comissions. 75 cents per option contract. Like a mosquito taking a bite of your cake.

 

[cnms2]

There's no free lunch: spreads reduce (change) your risk profile but cost you reward. Calendar spreads are a more complex strategy than verticals as they're also an implied volatility play, so don't take them lightly.

Quote from Neoxx:

...
I agree completely. The versatility is attractive and the complexity absorbing. Spreads are one of the strategies I definitely plan on implementing, especially calendar spreads.
...

 

[thenewguy]

Quote from Neoxx:

Hi,

Thanks for all the advice. Much appreciated.

I started out with mostly ATM calls, and learnt the effects of theta and vega the hard way. Fortunately, I started with a paltry-sized account and practiced good risk management so my lessons were cheap.

The reason I've decided to go more with ITM options now (delta 75-80) is so they simulate a leveraged stock position, while minimising vega, theta and gamma. At least that is my understanding. And I plan to limit my investment in any one position to 10% and my loss to 1%, based on the underlying support.

....

Lol, man, I could have written this word for word. I think I may be one step ahead of you in this process, for the moment. What I've just learned is that options with 75-80 delta's are sometimes high like that because they have really high iv. You buy those and no matter how right you are on price, if the iv caves in on you, you aren't going to make any money. You'll not make money in a hurry too.

I have a system designed to find stocks that are about to have a signifigant upward move, and trading the options around them I've learned only to pick one's that have low iv, then buy a strangle/straddle on them to take advantage of the iv movement as well as the price movement. If the price hits your target, you'll most likey have some good iv movement too to help out too. If it disasters against you, you will probably make money. If your system looks for short moves, however, straddles/strangles aren't much good. Oh, and theta will wack you twice, obviously.

I guess in summary, I've found it a pretty interesting and informative excercise to find some stocks via my system, then elimate the high iv ones and put some strangles and straddles on the low iv ones. imho it's a pretty safe way to learn about the dynamics of options in the real world, but I could be wrong. At least mr Market hasn't waited long in the past to tell me I was wrong...

Thanks,

- The New Guy

 

[Neoxx]

Quote from cnms2:

There's no free lunch: spreads reduce (change) your risk profile but cost you reward. Calendar spreads are a more complex strategy than verticals as they're also an implied volatility play, so don't take them lightly.

Oh, I realise that. I'm saving those for when I graduate. Plan to buy LEAPS and sell front-month, preferably overpriced, profiting from vega and theta.

Quote from thenewguy:

Lol, man, I could have written this word for word. I think I may be one step ahead of you in this process, for the moment. What I've just learned is that options with 75-80 delta's are sometimes high like that because they have really high iv. You buy those and no matter how right you are on price, if the iv caves in on you, you aren't going to make any money. You'll not make money in a hurry too.

I have a system designed to find stocks that are about to have a signifigant upward move, and trading the options around them I've learned only to pick one's that have low iv, then buy a strangle/straddle on them to take advantage of the iv movement as well as the price movement. If the price hits your target, you'll most likey have some good iv movement too to help out too. If it disasters against you, you will probably make money. If your system looks for short moves, however, straddles/strangles aren't much good. Oh, and theta will wack you twice, obviously.

I guess in summary, I've found it a pretty interesting and informative excercise to find some stocks via my system, then elimate the high iv ones and put some strangles and straddles on the low iv ones. imho it's a pretty safe way to learn about the dynamics of options in the real world, but I could be wrong. At least mr Market hasn't waited long in the past to tell me I was wrong...

Thanks,

- The New Guy

Yeah, that's one problem.

I was planning to minimise impact of IV and theta by buying ITM options with reasonable intrinsic value, and making sure I've got at least two or three months to expiry. The other appeal, as I wrote earlier, is I can hopefully manipulate my downside risk with prudent use of conditional stops.

I like your suggestion but my strategy picks up bullish continuation signals after a small retracement, so I don't think the moves are big enough to profit from straddles/strangles.

As far as IV goes, I'm only just starting to scratch the surface. I'll work that into the selection process once I have more of a clue

Neoxx