By: Tom Gentile
on January 10th, 2023
I want to wrap this 3-part educational series on Options Trade Management with education on types of closing orders.
When gets into an option trade, whether it be a bullish or bearish one it is considered opening an order or having an open order. Because options have an expiration date and the ones we trade are American style options when we end the trade that is called closing or placing an order to close.
You can buy to open and sell to close. Whether that be a call or put or a call or put debit spread it doesn’t matter: one would buy to open and sell to close.
If you do not close the option trade and take it into the options expiration date it will expire and depending on whether the options position is In the Money (ITM) or Out of the Money (OTM) will determine what happens to your account. If I go into all that can happen it would deviate me from the education I want to provide on this subject matter. Note – This could be future education
When one is closing an options trade there are a variety of types of closing orders, and you should work with your broker on the best ones to use and which ones they provide the capability of on their online trading platform
Types of Closing Orders
Some have termed placing a market order as one who is placing a bullseye on their forehead and saying to the markets to do with me as you will.
A Market order is one where you don’t specify a price and will take whatever the current market price is.
If you see a quote that shows the option is $2.00 x $2.05 one can place an order to sell to close at market. The risk is that by the time the order is filled that price can change and instead of selling it to close at $2.00 one gets $1.95 or $1.90 or lower.
A way to counter that from happening is to place a…
This is where you specify a price that you want to sell to close at and no lower than that price.
In the prior example where the option is currently $2.00 x $2.05 you can place a sell to close order at a limit of $2.00. This means closing the trade for $2.00 or higher, but no lower than $2.00; that is the limit price you are willing to part with this option.
Stop Loss Vs. Stop Limit
When I use the term Stop I am referring to stopping out of a trade at a loss. When an option trade is going lower in value that what you paid for it you run the risk of the option value going to zero and you losing 100% of your initial investment.
Instead of losing 100% you can place a stop order, meaning if the option value gets to a certain lower valuation you would say that’s enough pain or I want to stop losing money on this trade you would place a stop loss order.
A Stop-loss order to sell to close an option if the calculation of the option gets to a certain price point. Let’s say you bought to open an option for $3.00. You can place a stop loss order at $2.00. That means if the option goes to $1.99 the next trade would be your order to stop out or sell to close the option, which would be a market order to close and hopefully you get $1.99 and not any less.
A Stop Limit order is almost the same in that you are placing this order to stop the bleeding of the option valuation. The difference is you are specifying a price to sell to close.
If you bought to open the option at $3.00 and it goes against you can place a stop limit order at $2.00. But the risk is the option price gaps lower than $2.00 and instead of triggering a market order to close, the order will still be open and only when the option price comes back to $2.00 will it be filled.
The risk is that the option could go even lower than $1.99. It could go down to $0.50 and you will still be in the potion trade, until it goes back up to $2.00. There is even more risk in that it may NOT come back to that stop limit price and you run the risk into that option going until expiration and expiring worthless.
Which do we prefer?
We use limit orders (not stop limit) and that way while we are away from the computer intra-day and our price gets hit it fills and when we come back we can assess the result and focus on the next trade.
We can place our limit order to sell at a profit or at a loss and there is even an order called an OCO order.
OCO stands for One Cancels (the) Other.
This is where you are placing two conditional orders stating where you would want to sell to close the option for a profit or at a loss. If your order to fill, in this case sell to close the option for a profit gets filled the trading platform you are using should cancel the order to sell to close at the loss price you specified.
It should also work in the reverse where if your sell to close at a loss order gets filled the order to sell for a profit is cancelled.
This way when one order gets filled you are not at risk of the other order getting filled, which could result in you selling short a stock.
You should first find out if your online brokerage has this capability and then see if they can help you with live support or an online tutorial of how to place this type of order.
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