Explore Your Options by Tom Gentile
If Iím trying to manage option position risk to reduce my maximum loss exposure, is it better to tie a stop-loss to the market price of the options or the underlying stock?
Managed stops can be a good tool as they act as an extra layer of portfolio protection beyond our initial and known risk assumption if weíre dealing with a limited risk strategy. The question of exiting with a tighter managed loss based on the underlying share price versus the prevailing option market isnít as clear-cut. This is largely up to the individual trader and his or her risk acceptance, as well as the strategy being employed.
To illustrate with a simple situation that many traders can appreciate, say youíre bullish on shares technically and initiate an at-the-money long call strategy with less than 30 days until the contractís expiration. In this position type, you have clearly defined risk based on the number of contracts purchased multiplied by the purchase price.