Here are a few ideas for creating your own trading plan, along with some order types to consider implementing if they fit your trading objectives.
Basically, a trading plan is designed to pre-determine an exit strategy for any trade that you initiate. That's pre-determine, as in, before you actually enter the trade. If you make your trading plan in advance, your overall approach is less likely to be influenced by the market occurrences that can, and probably will, affect your thinking after the trade is placed.
Plan your options exit strategy
There's no one-size-fits-all trading plan, but it can be helpful to consider planning exit points based on a certain profit target or specific loss tolerance.
For example, suppose you bought the XYZ January 80 call for $3. You may want to set exits based on a percentage gain or loss on the trade. Using percentages instead of dollar amounts allows you to treat your trades equally. For example, some traders will exit options trades at a 50% loss or a 100% gain. So that's one of their guidelines they've established in their plan, at least on paper.
Exiting with a profit of 100% would mean selling the January 80 call for $6. If the price were to increase to more than $6, you'd get your original $3 back, plus $3 more, for a 100% return (minus transaction costs). Exiting the trade with a 50% loss would mean selling the call if it drops to $1.50, which is half the entry price.
Using stop orders
After entering the trade, you can place the orders that would close out the trade according to your plan. The profit exit could use a basic limit order to sell the calls at $6. The loss exit could use a stop order, which specifies a trigger price to become active, and then it closes the trade at market price, meaning the best available price.
In this example, you'd set a stop order at $1.50. Once the call option drops to $1.50, the order activates, and the option is sold at market price. Note: A stop order will not guarantee an execution at or near the activation price. No one knows exactly where a market order will fill. It could fill close to $1.50 or very far from that price. That's because once activated, these orders compete with other incoming market orders.
You could place these two orders together using an OCO order, which stands for "one cancels other." Once either order is filled, the remaining order is canceled automatically. The OCO aspect is what would allow two seemingly conflicting closing orders to be in effect at the same time.
Here's how to close out an existing position on the thinkorswim® platform (see image below). First, right-click the ticker symbol (or anywhere on that line) to pull up your order types. Fill out the quantity and price fields, and then select Confirm and Send.
Exit order strategy
Source: thinkorswim® platform.
For illustrative purposes only.
This same logic could apply to a bearish trade on XYZ. Suppose you paid $4 for the December 60 puts. You could try to close the order at a 100% profit (minus commission costs) by placing a limit order at $8. Or try to close them with a 50% loss by selling them with a stop of $2. Keep in mind, the stop order doesn't guarantee you'll get the trigger price. And, again, an OCO order might be useful for entering both orders.
Using trailing stop orders
Another options order type to consider is a trailing stop order. This is similar to the regular stop order, except the trigger price is dynamic—it moves in the direction you want the options price to go. If a stock or options price moves in your favor (the trailing stop adjusts up for a long position and down for a short position), the trailing stop gets closer to triggering when up and down price movements have been taking place (see image below).
Follow the trail; follow the trend
For illustrative purposes only. Past performance does not guarantee future results.
Let's say with the January 80 calls, instead of using the stop order to cut your losses, you use a trailing stop order of $1.50. This means the trigger price will be $1.50 lower than the highest price the option attains. If the option moves up to $5, then the trigger price will become $3.50 ($5.00 – $1.50). Stop orders can be used to try to lock in a profit rather than limit a 50% loss. If you hold a position that currently shows a profit, you may place a stop order at a point between the purchase price and the current price as part of your options exit strategy.
These options order types work with several strategies—on the long side as well as the short side. As a short example, let's say you sold a November 50 cash-secured put on XYZ for $2. On the profit side, you could enter a limit order to buy the puts for $0.05. Although you wouldn't receive 100% of your profit potential, closing the put eliminates the risk of remaining in the trade and may free up capital for other trades.
The exit trade on the loss side could be a stop order to buy the puts if the price rises to $3, which would exit the trade with a loss that's about 50%. Or you could use a $1 trailing stop order. If the puts dropped to $0.75, for instance, the trailing trigger price would be $1.75.
These are just a few different types of exit orders available, along with various order types for implementing your plan.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Please read the Options Disclosure Document titled "Characteristics and Risks of Standardized Options" before considering any options transaction. Supporting documentation for any claims or statistical information is available upon request.
With long options, investors may lose 100% of funds invested. Covered calls provide downside protection only to the extent of the premium received and limit upside potential to the strike price plus premium received.
Commissions, taxes, and transaction costs are not included in this discussion but can affect final outcomes and should be considered. Please contact a tax advisor for the tax implications involved in these strategies.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.0423-3K2G