[Options] When to Exit Options and Options Spreads

Sean McLaughlin
November 6, 2019

I recently received an email from a subscriber asking about best practices in exiting options positions:

How do you automate managing risk on options if you want to define it through the base stock price? E.g. you have calls on MSFT that you bought based on MSFT holding support at $100. Do you auto-sell (put a stop loss) on the option based on the MSFT price, not the option price itself?

Good question. And the answer is no. 

I do not put resting stop loss orders in options or options spreads because I don't want to get whipsawed out of a position by an intra-day move or even a bad print. For me, the most important price of the day is the closing price. I will wait until the end of a trading day to determine if a stock closes below my level. If it does, that is my signal to exit at the open of trading on the next day. I will then work a limit order to exit sometime early (but not at the exact open) that next trading day.

One very important reason the above works for me is because my positions tend to have defined risk -- meaning I know the absolute most I can lose in this trade and I've accepted this risk up front when I put the trade on. Or, in an undefined risk situation, I've sized my position such that any unlikely worst-case scenario might sting, but the risk would be entirely manageable for my portfolio. Because of this, there is never any panic to exit a trade. This allows me to be a calm, casual observer of price action who can sit through an adverse price move, wait for the closing price confirmation, and deftly exit after the open on the next day.

Additionally, I will never use a market order to exit an options position. Spreads are too wide and a market order is a virtual guarantee that I'll get filled at the worst possible price. No thank you.

If you do enough options trades, you'll see the wisdom of using limit orders to both enter and exit your positions. You'll often get filled in the middle between the bid and ask and those dollars add up over time. For example, if a call option is bid 50cents and offered 70cents, I'd put my bid in to buy at 60cents and I'll likely get filled pretty quickly.

I hope this is helpful for you as you consider the best ways to exit your trades.

~ @chicagosean

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