Risk Management
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Entering Options Orders and Managing Positions

Tony Zhang
October 22, 2019
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Entering Options Orders and Managing Positions

Learning how to trade options is a process that takes time and patience. A critical part of placing your first options trade is learning how to enter an order into your brokerage account. Entering options orders can be daunting due to the many variables involved. This post highlights the procedures and best practices for entering option orders correctly and the various techniques to use to manage an options position.  To learn more about how to enter option orders and manage your positions, view our latest webinar.

Opening and Closing Option Orders

Entering an order:

When establishing an options position, the first task is to establish a directional view on the stock or ETF – bullish, bearish or neutral. The next step is to select an option strategy, expiration date and strike price based on your directional view. Much like when entering a stock position, you can either buy or sell an option. However, on an options order you must specify whether you are opening a position or closing a position. When opening a position, a “To Open” order is used. This can either be a “Buy to Open” or a “Sell to Open” order, and each one can be placed using either a limit or market order.

Exit strategy:

Before you enter each trade, you should set yourself rules on when to exit the trade. It is important to have a sense of when to cut your losses or take your profits on any options position. When closing a position, a “To Close” order is used. This can be either a “Buy to Close” or a “Sell to Close” order, and each one can be placed using either a limit or market order.

Options Orders and Actions

As a first-time trader, you may be confused about whether to “Buy to Open” or “Buy to Close,” etc. Whenever you want to open a trade, you will use either “Buy to Open” or “Sell to Open.” Closing a trade requires using the opposite – either “Buy to Close” or “Sell to Close”:

 Table 1: Opening and Closing Options Orders

Source: OptionsPlay

Example of placing an open order:

The OptionsPlay tool will prompt you with the required parameters when entering an options order. Consider the example below of how to enter a call option order:

Table 2: Example of an Opening Options Order

Source: OptionsPlay

*As this is an “open” strategy, Buy to Open is used. Most brokers will populate the above parameters when an option is selected.

Example of placing a closing order:

The OptionsPlay tool will prompt you with the required parameters when entering an options order. Consider the example below of how to close a call option position:

Table 3: Example of a Closing Options Order

Source: OptionsPlay

*As this is a “close” strategy, Sell to Close is used. Most brokers will populate the above parameters when a position is selected.

Option Pricing and Liquidity

Options typically have wider bid/ask spreads than stocks and they vary depending on the market cap of each company. Large cap and less volatile stocks tend to have options with narrower spreads, compared to small cap and more volatile stocks that have wider spreads. Options on stocks that fall short of the top 20-30 symbols in terms of market cap tend to have narrower open interest and wider bid/ask spreads. This is important to keep in mind when placing limit orders. Pro tip: Don’t be afraid to place orders near the mid-point of the bid and ask price spread. Many orders are filled within 5-10 cents of the mid-point of the bid/ask spread.

Managing Options Positions

Once you have established an options position, there are best practices for managing each type of strategy. We have presented below, in summary form, a brief set of rules for managing each strategy. To learn more about each one, click on the link.

Cash-Secured Puts

This strategy generally does not require active management between order entry and expiration.

Goal: To acquire stock at a discount

Outcomes:

  1. Expires worthless – sell the put again to keep generating income if you still wish to acquire the stock.
  2. Exercised – you own the stock at the strike price of the put minus the premium received.

To learn more about best practices for cash-secured puts, visit our blog post and view our webinar on this topic.

Covered Calls

Goal: To strategically exit your stock position while generating additional yield on your asset.

The first two scenarios below do not require any management until the last week before expiration.

Possible scenarios:

  1. Stock moves above strike – the general rule of thumb in this case is to hold the position until the last week before expiration and then decide to either roll the call or let the stock be called.
  2. Stock moves sideways (below the strike price) – let the call expire worthless and sell another covered call to collect another premium.
  3. Stock moves lower – buy back the call option @ 20% of the premium received.

To learn more about covered calls, visit our blog post and view our webinar on this topic.

Credit Spreads

Goal: To let the credit spread expire worthless and keep the credit/premium.

Exit scenarios:

  1. Take profits early if there is a 50% gain with more than half the time left to expiration.
  2. Cut losses at 75%-100% if the credit received is greater than 1/5 of the vertical width.
  3. Cut losses at 100%-200% if the credit received is less than 1/5 of the vertical width.

To learn more about the best practices when selling credit spreads, visit our blog post and view our webinar on this topic.

Long Calls and Debit Spreads

In contrast to the previously mentioned strategies, which require selling options, long calls/puts and debit spreads require buying options. The rules for managing a long options position are relatively simple:

Rule for cutting losses:

  1. Cut losses at -50% of the premium paid.

Rule for taking profits:

  1. Take profits at +75%-100% of the premium paid.

To learn more about the best practices when buying calls/puts and debit spreads, visit our blog post and view our webinar on this topic.

Summary

When entering options orders, it is important to understand the difference between opening and closing orders. Many beginners find this concept confusing, and mistakenly open an additional position instead of closing their original position. On the other hand, once you have established an options position, understanding how to manage it depends on the strategy used. A few common best practices should be used to manage losing trades. Never add additional risk to a losing position, and taking partial profits can go a long way toward reducing overall risk in an options portfolio. Using best practices to enter and manage trades can help you maximize the effectiveness of your trades and minimize portfolio risk!

Take advantage of free access to OptionsPlay Canada: www.optionsplay.com/tmx

Disclaimer: The strategies presented in this blog are for information and training purposes only, and should not be interpreted as recommendations to buy or sell any security. As always, you should ensure that you are comfortable with the proposed scenarios and ready to assume all the risks before implementing an option strategy.

 

Tony Zhang
Tony Zhang http://tmx.optionsplay.com

Head of Product Strategy for OptionsPlay

OptionsPlay

Tony Zhang is a specialist in the financial services industry with over a decade of experience spanning product development, research and market strategist roles across equities, foreign exchange and derivatives. As the current Head of Product Strategy for OptionsPlay, Tony leads the research and development of their OptionsPlay Ideas & Portfolio platform. He has leveraged his interest in financial technology and product development to provide innovative, reimagined solutions to clients and the users they seek to serve. Previously he spent 7 years at FOREX.com with a capital markets and research background as a market strategist specializing in equity and FX derivatives markets.

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