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Advanced Options Trading - Options Vs Stop Loss Orders

Filed Under Advanced Options Trading 

Options Vs Stop Loss Orders
There is a laundry list of advantages of holding stock options over owning the underlying stock. Everybody knows about the lower costs, higher ROI (Return on Investment), and multiple strategies available with using stock options, but few are aware of the risk management strategies that options also offer.
 
According the Options Mastery Course offered by Options University, options are immune from the flaw that stop loss orders can have. For example, the bad news came out before the opening and the stock drops like a rock as soon as the markets open. The news hasn’t really hit the wires and before any action can be taken, your stop loss has been trampled and the stock is ten dollars lower before your stop order is filled. It happens all the time.
 
Sometimes, a stop is like that wimpy usher that shyly whispers “you can’t go in there”. You laugh and push yourself by. So, when there is some surprising or catastrophic news which can cause big moves, your peace of mind of having a stop loss in place is blown to pieces. You know, it isn’t the little losses that burn you; it’s the big ones where stop losses can be ineffective.
 
Options are different in that they are a “full time” stop that will work properly all the time. A strike price, once hit, becomes active from the get go. No worry about getting filled; either it is or it isn’t, period. Indeed, options were developed to become a perfect hedge.
 
For example, you think XYZ is going to be moving up within the next three months, so you decide to buy an at-the-money call. To protect yourself, you decide that you could accept a 5% loss so you figure out that buying a put that is $5 out-of-the-money will give you that down side protection during the option period. It doesn’t matter what happens, if the price hits the out-of-the-money strike, the put starts making money to help offset the losses suffered by the call. Of course, you must also figure in the cost of the put, which will lower the strike accordingly.
 
Brokerages recognize the safety of using an option as a stop to help reduce risk and can require much less margin to cover a trade. For example, suppose you set up a bear call credit spread where you sell a $50 call and buy a $52 call. The credit from the short sale usually more than offsets the cost of the long call so the risk is between $50 and $52; less than $200 per contract. Lower capital requirement also raises ROI.
 
Sometimes, setting up a bear call credit spread might require the precaution of setting up a stop for the short call if there is a significant spread between the short and the long.
 
For example, if you sell a $50 call and buy a $55 call, you might want to set a stop on the short call around $52 to get you out of the short and leave you long on the OTM call-or you can get totally out of the position. Why not just buy a $52 call? There may not be a strike at this price.
 

To find out more about all things stock option, contact the Options University for all of their online courses, webinars and mentoring services at www.optionsuniverstiy.com

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