TSC Options Forum: Stopping Options

The advantage is that it uses a more accurate assessment of technical support and resistance levels, providing a closer read on the "real" price action as opposed to a derivative, which leads to more timely executions.

Since options prices move in response to the underlying, they have an inherent delay and inaccuracy built in to the bid/ask in the form of wider spreads. This is sometimes referred to as "slippage" but I'll call it the "fudge factor" that market makers require for keeping risk low and profits possible. By tying an option stop-loss order to the stock price, you'd be anticipating rather than reacting to the options price movement; hopefully, this will result in a better execution price.

Another variation would be to use a stop based on a percentage change in the price in the underlying. For example, should the price of XYZ rise 5% the buy-stop on the short call will be activated. This is most often used on a trailing-stop basis, i.e., as the price of the underlying moves in your favor, you maintain a 5% price movement from the daily close as the price trigger.

The Order of Things

Of course, none of this matters if your broker tells you they don't accept such things as stops on options, contingency orders or percentage trailing stops. If you trade options with any regularity, find a broker that does accept them. Some names include Interactive Brokers, ThinkorSwim and OptionXpress.

They'll generally accept the above-described order types when dealing with a single strike execution. And while the spread execution has improved thanks to more advanced software, I don't know of anyone accepting stop-loss orders on multistrike orders. Nor would anyone want to use them. Market liquidity, lag time and slippage would only be exaggerated with more elements added to the option position.