Stocks & Commodities V. 31:3 (21): Futures For You by Carley Garner

Stocks & Commodities V. 31:3 (21): Futures For You by Carley Garner
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Futures For You by Carley Garner

Placing Stop Orders

Is it possible to place a stop order on an option?

As with option trading platforms, futures exchanges do not accept stop orders on electronically placed options. Some open outcry execution brokers might be willing to take the order by phone for execution in the trading pit, but in general, stop orders on options are a thing of the past. That said, even if it were possible to place stop orders on options, it isnít generally a good idea.

On the surface, having the ability to define approximate risk via stop order placement, similar to the way a futures trader does, is an appealing idea. Nonetheless, whether you are trading long or short options, the practice works much better in theory than it does in reality.

By definition, a stop order becomes a market order once the stated price becomes part of the bid/ask spread (bid is defined as the price at which you can sell, and ask is defined as the price at which you can buy). In other words, the order is elected once the price of the option, as determined by the spread between the bid and ask, reaches the stop price. Upon election of the stop order, the trade is executed at the best possible price available.

Exchanges do not accept stop orders on options because they are prone to excessive slippage. For instance, crude oil options rarely have market makers during the overnight session. As a result, the bid and ask of any particular option represents only those orders being worked by retail traders; in many instances, the spread between the prices can be excessive. During such off-market hours, it is not uncommon to see the spread between bid and ask in multiple dollars in premium (thousands in price).

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