When it comes to options, stop losses can be a little trickier than, say, equities. Bid/ask spreads tend to be a little wider, which means there is more ground to make up than something with a tighter spread. Let’s look at a general rule of thumb I use when it comes to stop losses and options.

Outrights

When just buying or selling a single-legged option, I tend to use a hard stop. I will put in a sell stop loss for long positions and a buy stop loss for short positions. The reason behind this is that since there is only a single leg, the bid/ask spread is usually tighter. The screenshot below is a stop loss on a long call position. The current bid/ask spread is only $0.10 wide, so there is less chance for slippage or a worse fill with the exit order set if the position declines to $0.70.

When buying or selling an option spread, a mental stop is usually more beneficial because the bid/ask spreads tend to be larger due to multiple legs. If the bid/ask spreads are generally tight, I still consider using a hard stop. The screenshot below shows a potential vertical call debit spread and a stop loss. Notice that the bid/ask spread is larger than the long call listed above. Here the stop loss is set to exit if the position drops to $0.30 in value. The bid/ask spread is now $0.15 wide instead of just $0.10 like above.

Whether you choose to use mental or hard stops is completely up to you. I hope this post will give you a few things to think about. The important part is that you have a stop loss in the first place.

John Kmiecik, Market Taker Mentoring