Placing Stops for an options Trade
for an options trade. Because pricing of options is not straight forward, the trdaers are always faced with dilemma of where to put to stop loss for their options trade.
Following is my approach for this. My stops are determined by following 3 conditions –
1) Money management based - I risk x% of initial investment i.e price paid to open the trade. If this limits is exceeded, then get out from the trade.
I don’t use fixed % based profit target for option position but let the chart dictate this for me. Till the time chart is not negating my initial view, I let profit run.
2) Price level of underlying stock / index - I use the chart of underlying stock / index and use technical anlysis to form my view about the security’s trend (rangebound or trend). Accordingly, I select the option trade i.e. rangebound trades like straddle/ strangle etc. or Directional position with Calls/puts or spreads or synthetics.
When price action on chart tells me that my view is no more valid, I come back to option position and close them. Even if the stops or targets is not hit.
We got to understand that options are derivatives hence when trading it, we got to monitor the underlying.
3) Date / Time based - As options are decaying asset, time decay becomes crucial factor specially near the expiry date. Some of the startegies benefit from time decay but many of them are hurt due to time decay. So depending on the strategy I am trade, I do set a cutoff point based on calender date beyond which I don’t want to carry the position.
Hope this gives you some idea about managing your options trade. As always, feel free to leave and comment or question.