"Based on What Price For Automatic Options Sale?"

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"Avoid Buying Options With Low Open Interest?"

"If a trader owns a put or call contract and wishes to program a sell order into their trading platform at a predetermined price should that price be set at a stock price or the option price? Thanks."
- Asked By Smokey on 20 May 2013

Answered by Mr. OppiE

Hi Smokey,

The price to use as a basis for selling out of a profitable or losing options position using advanced automatic orders can be a very tricky one. Both stock price and / or options price works depending on what exactly you are trying to achieve.

There are two main advanced orders most options traders use; Contingent Order (also known as Conditional Order) or Trailing Stop Loss Order.

Of the two, trailing stop loss orders automatically use options price and not the stock price. As such, it will automatically sell your option based on a predetermined amount retreat on the price of your option. This is useful when you are trading a short term momentum and wishes to take profit the moment that momentum ends.

Contingent order is the only order that allows you to choose between using options price or stock price as basis for exiting your options position. Deciding which one to choose basically depends on your specific options trading methodology. An options trading methodology based on options price would trigger on options price while an options trading methodology based on stock price action would trigger on stock price.

Options trading methodologies based on options price would be concerned only with how the price of the option is behaving and would have predetermined maximum loss and profit points based on the option's price and would have predeterminable reward risk ratio.

Using Options Price For Automatic Options Sale Assuming you bought 5 contracts QQQ's March $69 call options when QQQ was trading at $69 for $2.21, expecting QQQ to continue going upwards. You wish to limit your maximum possible loss on this position to 30% and take profit at 60%, making a reward risk ratio of 2:1. In order to automate your exit based on these criteria, you set up a contingent order to sell the position when the price of the March $69 Call Options are lesser than 2.21 x 0.7 = $1.55 as a stop loss and another contingent order to sell the position when the price of the March $69 Call options are greater than 2.21 x 1.6 = $3.55 as a profit taking point. A bracket order covering both price points can be used as well.

Options trading methodologies based on stock price action would be heavily reliant on trading a price swing on the price of the underlying stock with no specific corresponding exit prices on the options. Such trading methodologies will set stop loss point at where the stock is determined to no longer have a high chance of moving in the favorable direction or at a support level and set profit taking point at where the stock is determined to have ended a short term run or at a resistance level. The drawback of this method is that it can lead to unpredictable loss and profit which makes pre-calculating precise reward risk ratio impossible.

Using Stock Price For Automatic Options Sale Assuming you bought 5 contracts QQQ's March $69 call when QQQ was trading at $69 for $2.21, expecting QQQ to continue going upwards. You wish to hold on to this position for as long as the price of QQQ remain above its support level of $65 and would take profit once QQQ hits its resistance level of $75. In order to automate your exit based on these criteria, you set up a contingent order to sell the position when QQQ is lesser than $65 as a stop loss and another contingent order to sell the position when QQQ is greater than $75 as a profit taking point.

In conclusion, the decision of what price to base your automatic options sale on depends on your specific options trading methodology. One is more predictable but may lead to unnecessary stop outs due to volatility in the options price and the other is more unpredictable but may result in better profits and more wins due to holding on to the position as long as the stock is deemed still capable of running in the favorable direction.