Using contingent orders as a stop-loss strategy for options

Posted by BJLB on February 09, 2009 (06:40PM)

I have been trading options for a little over a month now. I have noticed that because of time decay on my ATM and ITM positions, I get stopped out of a position prematurely. I've tried a few strategies of setting my stops by price and percentage, but haven't found a formula that produces the risk management on options that I am looking for. I did however find one that I really like for stocks and I am wondering if anyone can help me figure out how to apply it to options as a contingent order that will work.

The stock strategy is to set a stop-loss that is 10% of 1 ATR less than the previous days low. (If shorting it would be the previous days high.) The way that I am trying to apply it is that if the underlying stock reaches the contingency, it will trigger a sell-to-close order. My attempts at applying it to options is not working as expected.

Example:
I am working with XYZ at 35 (Previous day was O=34.50, H=35.50, L=34, C=35) and I have the XYZ 30 CALL and it is priced at 3.00 with a bid of 2.90 and an ask of 3.00.

Lets just say the ATR is 1.50. 10% of the ATR is 0.15 so my contingent trigger on the stock is the low of 34 less the 10% of 1 ATR. 
    34.00-0.15=33.85

So I enter in a sell-to-close order for the call with a stop of 2.90.
The contingent is set to Last Price, Less Than 33.85

The next day the stock drops to 33.83. The contingent is triggered but the option stop order is rejected.

I have also tried setting a limit side also or limit only, but my attempts at setting a limit ends up being too tight most of the time and the stock continues to fall but I am unable to get out of the option until the order is cancelled and I do it manually. Any suggestions as to how I can regularly set a limit, stop-limit or stop so that it is always accepted?

Posted by BJLB on February 10, 2009 (01:04PM)

Well I decided to try having the order set as a market order, against TK advise on the preview screen and the best thing I can say is that I am taken out of the position. Overall, though, I don't think this strategy is going to work.

On another account I had a Visa call that held $100 profit yesterday, and today only broke even, less commissions.

On this account none of my positions that got closed out today were profitable, yet, but the losses have been cut to less than 30% on average. I would like a strategy that would keep the losses below 20%. Any ideas, anyone?

Posted by JBOOGZ2000 on April 04, 2009 (01:22PM)

I have been using contingent orders for some time to enter and exit my option trades usually when i enter a trade i try to calculate what the option price would be at my entry point by using delta. I then base my order on the price of the stock with a limit option order based on my calculations. When i exit i always use market orders some are against that but it works for me i like to get in at the price i like and exit at the market price. My exit order is dependent upon the stocks price according to my exit system i use a contingent order and if hit my option gets closed at the market price. I do not recommend using the market order if the option has no liquidity. I also, only use stops when my system tells me to put them in

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