Lesson Overview

Market, Limit, Stop Loss Orders

Online brokerages provide many types of option orders to fulfill our various trading needs. The common types of orders available are market orders, limit orders and stop loss orders. In this video we explain how each is used for today's option trader.

For nearly all of the training that we do here on Option Alpha we will use limit orders. This guarantees the price that we get into or out of a trade which is how we would ideally like to make decisions because we do not need to trade fast enough to use market orders throughout the day. As position traders we have the ability to wait for a price.

More Discussion

Was This Helpful? Add Comments/Questions

  • James W

    Kirk, for new traders with infinite risk trades, do you recommend setting up advance 3x stop loss orders, or do you suggest monitoring until it hits 3x and then submitting a sell order? I know that stop loss orders are debated a lot. Thanks.

    • Ultimately it depends on your risk tolerance. I think you could set automatic orders for exit and stop so it removes your emotions from the trading environment. In my case I do not set stops on anything because my position size is so small to begin with I don’t feel the need to do it, and will let positions work themselves out.

      • James W

        Thanks. On your exit guide, you publish a 3x stop loss on strangles, etc. How important is that in forming your strategy?

      • That’s a guide and so it’s the best overview for all traders but again for my own personal strategies I don’t use them.

      • SuperProducer Firetracks

        Hi Kirk, could you explain this what you mean by this a little more? Are you saying that you’ve already determined how much you’re willing to lose so you don’t bother with a stop? If so wouldn’t a trailing stop be in your favor any day?

      • If it’s a risk-defined spread I won’t use a stop but if it’s undefined risk (like a strangle) then I would use a defined stop loss level.

      • Matt

        Truly great info here…. I could be wrong, but I thought during your podcasts or tutorials we could hear trades being processed. Are those trades based on Stop orders or are you actively trading while during a podcast or tutorial? I like the idea of keeping things consistent.

      • Trades on the podcast are real trades we made the day of the recording.

  • Depends on the broker but usually executed or attempted the last minute of trading.

Show Video Transcript +

Hello everyone, and welcome back to Option Alpha. In today's video, we're going to go over all the different types of orders that you can put in for an options trade. Today, we're going to look at just the QQQ, and this is the trading screen that we have up via Thinkorswim who's our broker.

So you can see that under the QQQ, it last traded at 53.87, and it was up about 14 cents on the day. Below here, it's all the different option expiration periods, so we can trade on the Q. We're just going to select January just for simplicity's sake.

Scroll down and you can see that the calls are on the left side and the puts are on the right side. Again, we're just going to simply pick one of these trades here, let's say the January 57 strike call, here, and click the ask price to create a buy order.

Let me scroll up the screen here, and now here's our order dialog box down here at the bottom. Again, we're going to go over all the different types of order types that you can put into the market, but let's first explain what this is.

This is a single order to buy. And you see you can change it here very easily to a sell order if you wanted to sell. This is a buy order for one contract of the Q, January 2011, 57 strike call.

Again, you can see how I can change the strike here easily. I can easily change the expiration period, and I can even change it to a put on the put side. You can see the price will change accordingly.

Right now, this option is trading at about $26 per contract, and you can see, right now, I have a limit order in. Again, let's go over all the different types of orders and what they mean as an options trader.

The first one, obviously, is this limit order. Basically, the word means what it is. It's the limit. It's the most you will pay for that option contract. As soon as you hit confirm and send, it will go into the market and say, "I will never pay more than $26 for this contract."

Now, again, you can move this higher and say, "I'll never pay more than 30," or you could even move it lower and say, "I want to pay 25," and wait till the stock decreases in value just a little bit. That's a limit order.

The next order that we have in this long series is a market order. Now, a market order ... You can see the price just went away. With a market order, you get the next available fill for that option.

Now, I usually don't suggest that people enter market orders because the next available fill could be higher, lower than 26, and you just don't know where it's going. The best thing is always to use a limit order when you're getting out of trades.

When you get into a trade, you might not want to use a limit order. Some people prefer to use market orders because the market's rallying hard or selling off hard, and they just want to get into the trade before the next big move. That's when they'll use a market order.

Now, the next type of order that we have is a stop order. Basically, this is an order that is for option contracts that you already own, and you want to protect yourself. You hear stop loss and create a stop order all the time, right? Let's assume that you already own this January call option.

We're going to create a stop order to get out of the position in case it turns south on us. Instead of using the buy side, we're going to be on the sell side, and we're just going to be selling the one January 11, 57 strike call that we already own.

You can see, here, that the price has a market component to it, but it also has a STP, or stop component. This is really the big benefit to using a stop order.

Basically, this stop price is saying, "Okay. If, let's say, we bought this at 26, and if it gets down to a price level of 20, we want to get out of the trade automatically at the next nearest market price." Basically, it's a stop loss that's going to prevent you from losing any more money than about $6 on the trade.

Again, this is an automatic order, so as soon as you put this order in and you make it for a continuous period, then this order will be working for you even when you're not watching the market.

This is a great way to protect yourself from any losses that can come up unexpectedly in the morning, or after work, or while you're at work. This is a great way.

Now, the next way we can protect ourselves is by a stop limit, and notice that the market component of the stop limit order went away. We still have this STP component down here, this stop component, and it says we want to stop and enter this order when it gets down to 20.

But we only want to get out of the trade at, say, a limit price of 21. Basically, what you're saying with this trade is that if it gets down to 20, I want to try to get out at 21, if possible, and not the next nearest price as you would with a market order.

The drawback to this is, obviously, that the stock option could continue to fall below 20 and never hit 21, and you would still be left with a loss. If you use a limit order, I suggest you use a limit order at the same price as your stop loss, that way you know that it's traded at 20, and you know you can get out at 20.

I see a lot of young traders who try to create a limit order at 22, and the stock option falls in value and never looks back and never recovers back to 22. They're left with a huge loss.

Okay, continuing on. The next one is a trailing stop. Now, this one's a favorite of mine for stocks and option, both. Basically, what this is saying is that it's going to trail the market price by 10 cents.

We have a trailing order, and we have the market price. Every time that the stock option moves up in value, then our stop loss moves up in value to protect ourselves, and we'll never lose more than 10 cents.

Let me give you an example on this one. If we had bought this option at $26 and it immediately went south and declined in value, we would never lose more than 10 on that trade. If we bought it at 26, we would lose about 10, leaving us with 16.

Now, let's say we bought it at 26 and it increased and now it's worth 36. Now our stop loss, our trailing stop loss is going to move up accordingly with the price of the option. Now, we will never lose more than 26 which is 10 less than 36 where it's trading at now.

Again, this is a really good way to "let your winners ride" as they usually say in trading is to get into a trade, creating a trailing stop, and let the winner, or the market, ride higher. Your stop loss protects you and locks in profits all the way.

Now, another variation of this I the trailing stop limit. Again, you can see that this order right here has a market component. The same thing we just talked about with the stop limit, the trailing stop limit has this same component.

Let's say it's trailing, but I never want to get out at a price lower than, say, 26, or where I bought it at. Again, this is a little bit more of a risky trade, but as always, you have your risk component to each and every individual order.

The last two orders are the market on close ... This is, again, another variation of a lot of traders who try to enter the trades at the end of the day so that they take limited advantage of the time, the k-factor of options, especially when you're buying options.

We'll just say we're going to buy an option on this side, here. Change this back to buy. Basically, it's saying that I want to buy this option on the market, so any price at the end of the day.

I don't want to buy it now, but I want to buy it at the end of the day, or as close to the end of the day as possible. Again, you can get any price for this option, so I'd be just a little bit cautious on when you want to enter this order.

The last is the limit on close. Again, basically, this is saying, just like a limit order, that I want to buy this option at the close, but I'll only pay a limit price of, say, 25. Now again, if the market closes higher than 25, you're not going to get filled. But if it closes around 25, you may get a fill on this limit on close order.

Again, those are the main types of orders that you can enter for an options trader. Again, this has been a very simplistic look at it. As always, we invite you guys to look at our website and all the great articles we have.

As always, happy trading.

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