A stop loss is not an Options Adjustment technique, but it may often be considered as an alternative for those trading single Options strategies such as a Long Call, Long Put, Short Call or Short Put.
The trader specifies a level at which they wish to exit a trade and if the price moves through it, the stop order is executed by the broker (or lodged directly with the exchange). This should take the trader out of the trade and prevent further losses. Note that if the market direction reverses after the stop has executed, the trader will lock-in losses and not participate in any subsequent gains.
Stop losses are not usually guaranteed (in particular with Options instruments) and sometimes if the prices gaps (i.e. opens above or below the previous close) then the stop order might be executed at a level some distance away from where the trader wanted to exit. This can increase the loss to a level that might be greater than they expected.
Conventional stop losses are issued as what is called market orders, this means they execute at whatever price is offered next by another trader and these might be more or less favourable than the desired exit price.
There are various alternatives to standard stop losses such as stop-limit orders which will only execute if the price is below a given threshold but above a lower limit (i.e. between two points). These reduce the risk of the price being further away than the one the trader wishes to exit at, but in a fast-moving market they might not execute if the price has moved below the lower limit (e.g. the gaps scenario described above)
Stops can also be used to automate more complex Options strategies or to Leg Out of trades. In general, stops tend to be used less frequently with Options Trading compared to other instruments because the market for Options is not as liquid as stocks, for example and they are harder to control. With that said, they do have a role to play in Options Trading, especially when a trader is not in a position to sit in front of a screen to manually execute orders.
Contributed by: Ralph Windsor
The trader specifies a level at which they wish to exit a trade and if the price moves through it, the stop order is executed by the broker (or lodged directly with the exchange). This should take the trader out of the trade and prevent further losses. Note that if the market direction reverses after the stop has executed, the trader will lock-in losses and not participate in any subsequent gains.
Stop losses are not usually guaranteed (in particular with Options instruments) and sometimes if the prices gaps (i.e. opens above or below the previous close) then the stop order might be executed at a level some distance away from where the trader wanted to exit. This can increase the loss to a level that might be greater than they expected.
Conventional stop losses are issued as what is called market orders, this means they execute at whatever price is offered next by another trader and these might be more or less favourable than the desired exit price.
There are various alternatives to standard stop losses such as stop-limit orders which will only execute if the price is below a given threshold but above a lower limit (i.e. between two points). These reduce the risk of the price being further away than the one the trader wishes to exit at, but in a fast-moving market they might not execute if the price has moved below the lower limit (e.g. the gaps scenario described above)
Stops can also be used to automate more complex Options strategies or to Leg Out of trades. In general, stops tend to be used less frequently with Options Trading compared to other instruments because the market for Options is not as liquid as stocks, for example and they are harder to control. With that said, they do have a role to play in Options Trading, especially when a trader is not in a position to sit in front of a screen to manually execute orders.
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