Stop Loss Exit Rules Explained
In Options Auto Trader, setting up stop loss exit rules is an essential part of risk management. These rules help you minimize potential losses by exiting a trade if the market moves against you. We support three types of stop loss exit rules: Stop Loss Percentage, Stop Loss Amount, and Trailing Stop Loss Percentage. This article explains each type and provides examples using options selling scenarios.
Stop Loss Percentage
A Stop Loss Percentage rule automatically exits a trade if the option’s price moves a certain percentage against your position. This is useful for options sellers who want to limit losses by setting a percentage-based threshold.
Example:
Let’s say you sell a covered call and collect a premium of $2.00 per contract. You set a Stop Loss Percentage at 50%. This means if the price of the option you sold increases by 50%, reaching $3.00, the system will automatically exit the trade to prevent further losses.
- Sold Price: $2.00
- Stop Loss Percentage: 50%
- Trigger Price for Stop Loss: $3.00 (2.00 + 50% increase)
If the option’s price increases to $3.00, the trade will be closed, helping you prevent even larger losses.
Stop Loss Amount
A Stop Loss Amount sets a fixed dollar amount as your maximum loss. This type of stop loss is beneficial if you prefer a clear monetary threshold for when to exit a trade.
Example:
Imagine you sell a cash-secured put and receive a premium of $1.50 per contract. You set a Stop Loss Amount of $100. This means if the trade loses $100 in total, the system will automatically exit the trade.
- Premium Collected: $150 (since one options contract represents 100 shares, the premium is 1.50 × 100)
- Stop Loss Amount: $100
If the trade results in a $100 loss, the system will exit the position, locking in the loss and preventing it from growing larger.
Trailing Stop Loss Percentage
A Trailing Stop Loss Percentage adjusts dynamically as the market moves in your favor, but exits the trade if the market reverses by a specific percentage. This is particularly useful for letting profits run while still having protection in case the market turns against you.
Example:
Assume you sell a covered call for a premium of $2.50 per contract and set a Trailing Stop Loss Percentage at 30%. The trailing stop follows the option's price as it drops (which is good for options sellers). If the price increases by 30% from its lowest point, the system will trigger an exit.
- Initial Sell Price: $2.50
- Lowest Option Price: $1.50 (as the market moves in your favor, the price drops)
- Trailing Stop Loss Percentage: 30%
- Trigger Price for Exit: $1.95 (a 30% increase from the lowest point of $1.50)
If the price of the option increases from $1.50 to $1.95 (a 30% increase), the trade will exit, locking in your gains before the market potentially reverses further.
Choosing the Right Stop Loss Rule
When setting up stop loss exit rules, it’s important to consider your risk tolerance and trading strategy:
- Stop Loss Percentage: Ideal for traders who want to limit risk based on the price movement of the option.
- Stop Loss Amount: Best for traders who prefer a specific monetary limit on their losses.
- Trailing Stop Loss Percentage: Great for traders who want to protect profits and limit risk while still allowing the market to move in their favor.
Conclusion
Using Stop Loss Exit Rules in Options Auto Trader helps safeguard your capital and manage your risk effectively when selling options. Whether you use a percentage, fixed amount, or trailing stop, these rules provide flexibility in managing your trades according to your risk tolerance. If you need further assistance setting up your stop loss rules, feel free to contact our support team.