Setting Stop-Losses

Posted by Trend Follower on October 21, 2008 (01:58PM)

How are you determining where to set the stop loss on your option contract.  I have heard many different opinions to this and wanted to get some advice.  Thanks for the help!

Posted by NakedMoleRat on October 21, 2008 (04:34PM)

I am not really sure.  I think it depends in part on the type of option contract and the underlying stock.  Other factors will be your risk tolerance and how you see the stock behaving.  Is there a particular type of option contract that you are wondering about?

Posted by Trend Follower on October 23, 2008 (02:05PM)

No not exactly.  I am just having trouble with it as a general rule.  There are times where I will sell an option due to its decline in value but then the contract will perform exactly how I expected.  Then on my next trade I will hold onto one and be incorrect in my desicion.  Typically what I do is I will hold the contract until the underlying asset reaches a value that contradicts my initial opinion of the trend.  The problem is that (whether due to implied volatility or otherwise) the option contract does not perform in the manner I expected relative to the change in stock price.  I was just asking to see what others were using as a general rule, and then I could tweak it from there.  Thanks for your response.

Posted by snowman on October 23, 2008 (02:30PM)

Depends on the Stock or option. I would say as a general rule 35% loss. Sometimes on smaller stocks you enter the position with a 15% to 20% loss. So it depends.

Posted by tasman on October 30, 2008 (04:33AM)

I set my stop loss at 50%, but I do not buy or hold contracts with less than 30 days to expiration and try to buy at least 75 days or more to expiration. If I was trading closer to expiration, I would not risk nearly that much.

Posted by Trading Options For Income on February 20, 2009 (11:20AM)

The important thing to remember is that options are different instruments than stocks and have to be traded differently. I have never been a big fan of using stop loss with options and especially with option spreads. 

With stocks there are clear reasons to use a stop loss. For example if the stock has hit a specific point such as your maximum acceptable loss or a critical support level, the stop loss makes sense. With options it is a bit different because there are so many factors that go into the pricing model. You can get stopped out of a trade by something that is temporary in nature and not material in the original sentiment for buying or selling the option in the first place. Spikes and implosion in implied volatility for example can easily stop you out of a trade even though your position may be performing in your favor from a directional standpoint.

An important consideration, especially when placing stop loss on a spread, is to know what method a broker uses to trigger the stop order. Usually, when these trades are triggered, the resulting transactions terms are not very favorable.  

CJ Mendes

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