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How to Use Stop Loss in Options Trading?

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Written by Timothy Sykes
Updated 4/21/2023 9 min read

Using a stop-loss in options trading is one way that traders protect themselves.

Normally, I’m not a fan of stop-loss orders — it takes control away from me.

It’s one way that lazy traders try to “set it and forget it.” It’s a good way to get stopped out of a trade in the volatile stocks that I like to trade.

Setting a stop-loss on an options trade can be a bit different from day trading the penny stocks that I concentrate on. For one thing, you’re usually dealing with longer time frames. An options trade can expire in weeks or months.

I want you to understand the pros and cons of any strategy. After you do, you need to choose the best strategy for YOU.

Read on for a deep dive into stop-loss orders and learn how you can use them!

What Is a Stop Loss Order?

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A stop-loss order is an order to trade an asset once it reaches a certain price. It’s common in stock and options trading as part of a trader’s exit strategy. You generally use this order type to limit losses or lock profits in.

If you’re trying to limit a loss, you’d set your stop-loss below the current price. This is more common in stock trading than options trading, as you can just allow your losing options trade to expire. However, a stop-loss can help you trade the contract and recoup some of your premium.

If you’re trying to lock in a profit on an options trade, it gets a bit more complicated. You might set your stop loss above the strike price but below the current price, letting your trade run but protecting it from falling back into non-executable territory. Or you could set it above the strike price and above the current price, setting a trade in motion at the point you specify.

Another variant is called a “stop-limit order”. With stop-limit orders, you set a stop that the trade becomes active at, and a limit that it will execute at. Stop-limit orders help you regulate the buy or sell price better than stop-loss orders.

Like I mentioned above, the danger of these order types is that they take your hand off the wheel. Even if you want to manually enter in an order after a stop order is placed, you’ll first have to cancel the previous order. This can cost precious seconds that you may not have to spare.

Are you new to trading options? Check my guide on learning options trading. You should also read more about the risks of option trading before jumping in.

How to Use Stop Loss in Option Trading

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A stop-loss in options trading is like stop-loss in stock trading. You set the order at a certain trigger price.

When the asset price crosses the stop, your online trading platform will attempt to trade your options contracts. That is, as long as there’s a buyer.

Your stop-loss might not trigger if the market is closed. But it’ll be queued for when the market opens on the next trading day, unless you have extended hours trading enabled.

You need to learn the trading lingo before getting into options trading. Read my deep dives about open interest, option spreads, and option deltas.

Advantages of a Stop Loss Order

Why do people use stop-loss orders? Here are some advantages:

Gives You Room to Breathe

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Trading can be intense at times. You might be looking at charts for hours each day. Watching Level 2 can feel like the world’s longest, most heated ping pong battle. Sometimes you just want to take a breather without exiting your current positions.

That’s where stop-loss orders can come in. You set a stop and can step away, knowing that you’re protected.

I don’t endorse this, but I can see the appeal. Trading should fit your lifestyle, that’s one of the big attractions.

Prevents Emotional Trading

I try not to get emotionally attached to my trades. But even after 20-plus years, I can still hold onto a position too long.

If that’s me, imagine what happens when you’re a newbie!

When a trade doesn’t go according to plan, it’s human nature to abandon your trading plan. You start to believe prices will bounce back. But a lot of the time, they don’t.

Stop-loss orders can give you the safety net needed if you’re still working on your discipline. They force you to follow your plan. Taking the choice to exit out of your impulsive hands might save you from big losses.

Disadvantages of a Stop Loss Order

I find there are more disadvantages to stop-loss orders than advantages. Here are three of my biggest gripes:

Vulnerable to Short-Term Price Fluctuations

Stop-loss orders kick in when the current price hits the trigger price. That’s a good thing, in theory. But it can be messier in practice, especially with short-term price dips.

The stop-loss order will trigger if the price dips to your trigger price before bouncing back. This is called getting “stopped out.”

You Lose Control Over Trades

Your stop-loss order becomes a market order once it reaches the stop price. If you need reminding…

Stop-limits are much better. But even they have risk…

Sometimes a falling stock falls past your stop, becomes executable, but blows by your limit too quickly! You trusted your stop, and got distracted…

Now you’ve dug yourself a hole you didn’t have to. Trading is a battlefield, and you were the fighter jet pilot on autopilot.

You’re at the Mercy of Market Makers

Market makers can see your stop-loss orders, and they can’t resist. The mission of market makers is to create liquidity…

And your stop-loss may be an unwilling participant in the push for volume.

This is one of the most important reasons I don’t use stop-loss orders. Part of being a safe trader is not leaving the keys in the ignition.

Key Takeaways

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I don’t use stop loss-orders because I’m giving up control. But they might fit your strategy — and that’s what matters.

Whether you use stop-loss orders or not, the rules of responsible trading still apply:

  • Don’t copy other people’s options trades. Nobody can make individualized recommendations for you because everybody trades differently.
  • Learn from experienced options traders. Make sure the people you learn from are reliable sources.
  • Make your own stock watchlists. Do your research and make informed trades.
  • Build and follow a trading plan. This is the cure for emotion-driven trading, and the only scientific way to approach your trading goals.
  • Record every trade for future review. Improve your strengths and patch up your weaknesses.

Options trading is one of the hardest things you’ll ever learn. You can’t expect to get good within days.

What’s important is improving your skills with every trade. You can learn from good and bad trades. So, don’t be afraid to make mistakes.

How do you master options trading strategies? Learn from experienced traders like my former student Mark Croock. He made most of his $4 million in career earnings from options trading. He’s taught in my Trading Challenge for a long time, and now he’s leading his own options trading mentorship program!

The program is Evolved Trader, and it’s your one-stop shop for all of Mark’s strategies, trade alerts, even trading tax prep (he used to be an accountant!). Whether you’re just starting out or well on your way, having Mark on your side will make a big difference.

Do you use stop-loss orders? Let me know how they work with your trading strategy in the comments!

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Timothy Sykes

Tim Sykes is a penny stock trader and teacher who became a self-made millionaire by the age of 22 by trading $12,415 of bar mitzvah money. After becoming disenchanted with the hedge fund world, he established the Tim Sykes Trading Challenge to teach aspiring traders how to follow his trading strategies. He’s been featured in a variety of media outlets including CNN, Larry King, Steve Harvey, Forbes, Men’s Journal, and more. He’s also an active philanthropist and environmental activist, a co-founder of Karmagawa, and has donated millions of dollars to charity. Read More

* Results are not typical and will vary from person to person. Making money trading stocks takes time, dedication, and hard work. There are inherent risks involved with investing in the stock market, including the loss of your investment. Past performance in the market is not indicative of future results. Any investment is at your own risk. See Terms of Service here

The available research on day trading suggests that most active traders lose money. Fees and overtrading are major contributors to these losses.

A 2000 study called “Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors” evaluated 66,465 U.S. households that held stocks from 1991 to 1996. The households that traded most averaged an 11.4% annual return during a period where the overall market gained 17.9%. These lower returns were attributed to overconfidence.

A 2014 paper (revised 2019) titled “Learning Fast or Slow?” analyzed the complete transaction history of the Taiwan Stock Exchange between 1992 and 2006. It looked at the ongoing performance of day traders in this sample, and found that 97% of day traders can expect to lose money from trading, and more than 90% of all day trading volume can be traced to investors who predictably lose money. Additionally, it tied the behavior of gamblers and drivers who get more speeding tickets to overtrading, and cited studies showing that legalized gambling has an inverse effect on trading volume.

A 2019 research study (revised 2020) called “Day Trading for a Living?” observed 19,646 Brazilian futures contract traders who started day trading from 2013 to 2015, and recorded two years of their trading activity. The study authors found that 97% of traders with more than 300 days actively trading lost money, and only 1.1% earned more than the Brazilian minimum wage ($16 USD per day). They hypothesized that the greater returns shown in previous studies did not differentiate between frequent day traders and those who traded rarely, and that more frequent trading activity decreases the chance of profitability.

These studies show the wide variance of the available data on day trading profitability. One thing that seems clear from the research is that most day traders lose money .

Millionaire Media 66 W Flagler St. Ste. 900 Miami, FL 33130 United States (888) 878-3621 This is for information purposes only as Millionaire Media LLC nor Timothy Sykes is registered as a securities broker-dealer or an investment adviser. No information herein is intended as securities brokerage, investment, tax, accounting or legal advice, as an offer or solicitation of an offer to sell or buy, or as an endorsement, recommendation or sponsorship of any company, security or fund. Millionaire Media LLC and Timothy Sykes cannot and does not assess, verify or guarantee the adequacy, accuracy or completeness of any information, the suitability or profitability of any particular investment, or the potential value of any investment or informational source. The reader bears responsibility for his/her own investment research and decisions, should seek the advice of a qualified securities professional before making any investment, and investigate and fully understand any and all risks before investing. Millionaire Media LLC and Timothy Sykes in no way warrants the solvency, financial condition, or investment advisability of any of the securities mentioned in communications or websites. In addition, Millionaire Media LLC and Timothy Sykes accepts no liability whatsoever for any direct or consequential loss arising from any use of this information. This information is not intended to be used as the sole basis of any investment decision, nor should it be construed as advice designed to meet the investment needs of any particular investor. Past performance is not necessarily indicative of future returns.

Citations for Disclaimer

Barber, Brad M. and Odean, Terrance, Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors. Available at SSRN: “Day Trading for a Living?”

Barber, Brad M. and Lee, Yi-Tsung and Liu, Yu-Jane and Odean, Terrance and Zhang, Ke, Learning Fast or Slow? (May 28, 2019). Forthcoming: Review of Asset Pricing Studies, Available at SSRN: “https://ssrn.com/abstract=2535636”

Chague, Fernando and De-Losso, Rodrigo and Giovannetti, Bruno, Day Trading for a Living? (June 11, 2020). Available at SSRN: “https://ssrn.com/abstract=3423101”