Stop Order

Stop Order is an order (buy/sell) to close a position that only executes when the current market price of an option/stock hit or pass through a predetermined price (i.e. Stop Price).
Once the Stop Price is passed, the Stop Order would convert into a Market Order, and will be filled at the best available price in the market at that time.
Stop Order is also known as Stop Loss Order or Stop Market Order.

Stop Order is commonly used to limit / reduce losses on a position when the price moves sharply against the trader/investor, or to lock in profit from a position to prevent you from “giving your profit back to the market”.

Depending on the position on the market you have (long or short), there are 2 types of Stop Order:
a) Sell Stop Order
This is the stop order (to limit losses or to lock in profit) when you have a long position on a security.
In this case, the Stop Price is placed below current market price of the security.

b) Buy Stop Order
This is the stop order (to limit losses or to lock in profit) when you have a short position on a security.
In this case, the Stop Price is placed above current market price of the security.

Note:
When placing Stop Order for an Option, the order will be triggered based on the market price of the option, NOT the market price of the underlying stock. Therefore, the Stop Price should be set based on the option’s price as well.

Therefore, just remember how the price of Call and Put options are related to the underlying stock price:
For a Call option, the option’s price increases when the underlying stock’s price increases, and decreases when the underlying stock’s price decreases (positive relationship).
On the other hand, for a Put option, the option’s price increases when the underlying stock’s price decreases, and decreases as the underlying stock’s price increases (negative relationship).

Characteristic & Risk of Stop Order:
Stop Order will remain inactive until the Stop Price is passed. Once the Stop Price is passed, the order will be activated as a Market Order.
Therefore, the disadvantage of Stop Order is that while it guarantees execution, the order cannot guarantee that it can be filled at the specified price.
Basically, once the Stop Order has been triggered (i.e. when the price hits or passes through the Stop Price), it turns into a Market Order, which will be filled at the best available price in the market at that time.
This price may be “worse” than the predetermined Stop Price (i.e. lower for Sell Stop, or higher for Buy Stop), particularly during volatile price movement.
Hence, basically the same advantage & disadvantage of Market Order apply to Stop Order as well.

Example:
Suppose a Sell Stop order were placed to protect a long position on a Call option with a Stop Price at $2/contract. The current market price is $2.5/contract. This order would remain inactive, unless the price reaches or drops below $2. When that happens, the order would then be triggered and turn into a Market Order, and the option will be sold at the best available market price.
Hence, in case the market price gap down at $1, the price at which the order will get filled would be around that price, which is much worse than the stipulated Stop Price.

For the list of other types of order, go to: Types of Orders in Trading.

Related Topics:
* A Chance to Learn from World Class Trading Experts For FREE You Should Not Miss
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Learning Candlestick Charts
* Learning Charts Patterns

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How To Effectively Use Stop Loss To Protect Your Capital And Lock In Profits

As mentioned in the earlier post, a Trading System should be able to answer the following questions:

a) What stock to enter.
b) When to enter (Entry strategy).
c) How much to enter per position
d) When to exit (Exit strategy).

While many people place too much emphasis on the entry, they don’t really know when to exit. Actually, a trader should focus more on exit strategy than on entry strategy. Exit strategy is much more important than Entry strategy.
There are 2 types of exits a trader must consider to be parts of his trading system:
* When to exit on your losing position (i.e. Where to put your initial stop loss).
* When to exit on your profitable position (i.e. When to take your profit).

Trader’s Blog has previously discussed further and even posted a video about various Stop Loss strategies to protect your capital and lock in profits effectively.
Check it out! Get more insights from the “Comments” below that article too.

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* Trading Tips Video: Fibonacci Retracement, Support/Resistance, Stop Loss, Price Target
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Understanding Option's TIME VALUE

Click the following links to read each of the articles:

1) More Understanding about Options Time Value
2) Main Factors that Affect Option’s Time Value

3) Option’s TIME VALUE – Putting It Together:
a) Part 1: Understanding What It Is
b) Part 2: Main Factors – Degree of Options Moneyness
c) Part 3: Main Factors – Implied Volatility & Time to Expiration
d) Part 4: Behavior


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* FREE Trading Educational Videos You Should Not Miss
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Understanding Implied Volatility (IV)
* Option Greeks
* Learning Candlestick Charts
* Learning Charts Patterns
* Getting Started Trading

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Trading Video: Double Tops and Pivot Points Explained

A number of readers asked me if I’m going to write about reversal patterns (such as Double Tops / Bottoms, Triple Tops / Bottoms, Head & Shoulders Tops / Bottoms, etc.), as so far I only have posts on continuation patterns.
The answer is yes, it’s on my plan. While the articles on reversal patterns are still under preparation (coming soon, I promise), I found a cool trading video, which shares about Double Tops pattern.

Double Tops is one of the most frequently seen and common patterns, which can be traded in different time frames.
This video gives an example on Double Tops pattern under 15-min chart for S&P 500 on 6 Apr 09.
Hope you can learn something from this video.

Note:
Got this video from Trader’s Blog. It’s a great blog.
If you like it, you may want to subscribe to their updates, so that you can receive an alert when there’s new post or video.

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* FREE Trading Educational Videos You Should Not Miss
* Learning Charts Patterns
* Learning Candlestick Charts

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Happy Easter 2009

"He himself bore our sins in His body on the tree, so that we might die to sins and live for righteousness; by His wounds you have been healed."
(1 Peter 2: 24)

HAVE A HAPPY & BLESSED EASTER 2009!
May this Easter reminds us of His love in our life.
GOD bless you!

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Option’s TIME VALUE – Putting It Together – Part 4: Behavior

The Behavior of Time Value
As mentioned in Part 3, the Time Value component of an option price will decline or “erode” as expiration is nearing (i.e. Time Decay).

The rate of decline of option’s time-value resulting from the passage of time (i.e. rate of Time Decay) is known as THETA, which is one of the Options Greeks.

Comparing Theta at a certain point of time between ATM (At-The-Money), ITM (In-The-Money) & OTM (Out-of-The-Money) options, Theta is typically highest for ATM options, and gradually decreases as options move towards ITM and OTM.
This is understandable because ATM options have the highest time value component, so they have more time value to lose over time than an ITM or OTM option.

Comparing Theta over time, there are different behaviors between ATM and ITM / OTM options:
For ATM options, as the Time Value component of an option price decreases when the option is approaching expiration, the rate of time value decrease is accelerating (i.e. Theta is increasing) as it is getting closer to expiration.
This means that the amount of time value disappearing from the option price per day gets bigger with each passing day. For ATM option, time value decreases sharply particularly in the last 30 days before expiration.

On the other hand, for both ITM & OTM options, Time Value actually decreases at a decelerating rate as expiration nears. In other words, Theta decreases as the option is approaching expiration.
This means that the amount of time value disappearing from the option price per day gets smaller with each passing day.

This Time Value behavior can be seen in the following graphs:

1) Time Value of ATM Option:






2) Time Value of OTM Option:




Note: Both pictures courtesy of Sigma Options

Therefore, based on the above, we can summarize as follow:

For ATM options, Theta (i.e. the rate of time value decline as the time passes) is typically the highest (as compared to ITM & OTM options), and will be increasing (i.e. the rate of time value decrease is accelerating) as the option is nearing expiration.

For both ITM & OTM options, Theta is relatively lower (than ATM options), and will be decreasing (i.e. the rate of time value decrease is decelerating) as the option is nearing expiration.

The Impact of Implied Volatility (IV) on THETA
When Implied Volatility (IV) decreases, Theta will be lower, especially when it is approaching expiration.
On the other hand, when IV increases, Theta would be higher.

Why is it so?
As discussed earlier in this post, time value as the price that people are willing to pay for the chance / uncertainty as to whether or not an option will finish ITM.
The more uncertain, the higher the time value will be.

When IV decreases, such uncertainty will be lower, particularly when the option is nearing to expiration. This lower uncertainty will then be reflected in lower time value. Since Theta is the decrease of time value due to the passage of time, Theta will naturally be lower because it has less time value to lose over the remaining time to expiration.

Related Topics:
* FREE Trading Educational Videos You Should NOT Miss
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Understanding Implied Volatility (IV)
* Option Greeks

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