Jump to content
  • 0

Should I use stop losses on options positions?

Jane Goodwin


1 answer to this question

Recommended Posts

  • 0
General market wisdom is that using stop losses is highly recommended. There are certain market phenomena such as Flash Crashes and Whipsawing at the time of news announcements which can quite frankly infuriate traders. The fact that these events are hard to manage doesn’t negate the fact that stop losses are a crucial consideration. Stop losses in Options are a made a little more complex by the fact that you apply a stop loss that is triggered by a price change in the option itself, but which is essentially based on a price change in the underlying instrument of which the option is a derivative. Whilst the price of the option tracks the price of the underlier this relationship is not necessarily 100% ‘efficient’ so might not be completely correlated. If you’re using an Index options to hedge an Index position you’d be well to study how the pricing of the Option varies as a function of price changes in the Index. The option might not be providing the hedging that you require. Another key point to consider is that some option strategies, such as a ‘Straddle’ are based on the premise that you hold two option positions which work in combination. In this instance, applying a stop is not required. Your strategy, for example, holding Long Calls and Long Puts (in the same instrument but with different Strike Prices) relies on price movement, and both option positions remaining in place until closed out simultaneously. The main recommendation here is to check that the positions you put on are ‘correct’, a fat-finger error could result in the Straddle being misaligned and leave you open to the risk of losses. The type of stops that can be placed on the option position itself can look like the below screen grab taken from the City Index execution GUI. The ‘Advanced’ function allows the duration of the stop to be adjusted (variations along the lines of GTC) and for Trailing stops to be applied. The functionality is all very similar to that found in other markets. Selling short Calls or Long Puts options involves a lot of risk. For example, selling short Calls leaves you open to unlimited losses as the price of the underlier is technically unlimited to the upside. The related article is a salient reminder on the risks involved with betting against price moving to the upside: httpsss://financial-fraud.blogspot.com/2012/07/porsches-big-squeeze-mother-of-all.html.
Link to comment
Share on other sites

Join the conversation

You can post now and register later. To reply to this question, sign in or create a new account.

Reply to this question

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoji are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.


  • Create New...