Stops on option plays

Placing stops on option plays is extremely important for anyone looking to trade options profitably.  There are 3 ways you can limit the amount you lose on your option.

1.       Let it expire

I will use this every now and then when I am looking to either make a huge gain or a small loss.  What it means to let your option expire is simply this.  You buy an option a month or two out expecting a big move in the stock.  If it goes your way you could potentially get a return of 200-300% or more.

 If it does not go your way you would risk the entire amount of the option contract.  This is the only way to know exactly how much you are risking on the option contract.  But most people probably don’t like the idea of risking 100% of the money they put into an option so let’s talk about other ways to cut your losses short.

2.       Stop on the option

You can place a stop on the option contract itself.  So let’s say we buy an option for $5 and place a stop to close the position if our option is worth $2.5.  This way if we are wrong we are only risking 50% of our investment.

Our loss is lowered so we can feel confident that we will probably walk away with some of the premium we paid.

3.       Contingency Order

We could also place an order to sell the option based on what the stock is doing.  So if we find a stock that is bouncing off support we would expect a short term pop up, in which case we might buy a call option. 

Now if it breaks through support it is no longer a bullish sign.  So we might buy the option and put a contingency order to sell once the option breaks through support.

Of course all these are pointless unless you actually have a plan for getting into a position.