💲Exit Strategy
This is one of the best option trading strategies to lock in profits and prevent small losses from turning into big ones.
A Trailing stop loss is an advanced order type that can completely transform your options trading.
In this explainer we'll cover the basics of the trailing stop and the best strategies to use the order type to secure profits and prevent losses.
Key points:
The trailing stop sets your exit at a fixed amount that "trails" the bid price. If the price of the option falls the fixed amount, your broker will automatically market sell the position.
The benefit is that you can secure profits and limit your downside risk if the price action moves against you.
Trailing stops will hurt your profit if there's a "kill candle" (aka massive move in 1m bar) that is designed to hunt stops (aka liquidate traders) before continuing the move
Trailing stop orders are our favorite method to exit option trades!
Brokers that offer trailing stop orders for option trades
You would think every broker would offer their users this functionality, but some are more interested in robbing their customers than seeing their customers succeed "cough, cough Robinhood".
Most of the free options trading platforms like Robinood and WeBull do not offer trailing stop loss orders. In fact, Robinhood doesn't even allow you to do market sells because they profit off selling your order flow to Citadel. Here is a list of brokers that are confirmed to have trailing stop order types for options.
1.) E*Trade - probably the easiest (info here)
2.) Interactive Brokers - very hard to use for beginners
3.) TD Ameritrade
4.) Charles Schwab
5.) TradeStation
6.) Think or Swim
Trailing Stop Loss Orders for Options Pros and Cons
Generally trailing stops are used to lock in profit and limit your downside if the price action moves against you.
You can start learning how to use them in your trading by setting them whenever you are at your profit target.
Example:
Let's say we are trading a SPY 510 call option that we purchased for 1.00.
The price of SPY is moving up and the option is now 1.20 so we are up 20% on the position.
If we set a trailing stop loss to 0.03, then the least amount of money we will return is 1.17 (17%).
Advantages:
Risk Management: A trailing stop loss smartly climbs with the bid price of your option. It leaves room for gains and limits losses.
Downside protection: In volatile price action, it can stop a small loss from turning into a big one by market selling after the trailing stop is hit.
Less stressful: You can set a trailing stop and walk away knowing you've locked in gains and will catch any upside move that's left.
Disadvantages:
Kill candle risk: Often when price reaches a strike level (dollars for SPY/QQQ and various for stock options), there's a kill candle designed to hunt stop losses. Your trailing stop will hit and you'll exit the position missing the move.
Lose potential profits: If your stop loss order is triggered on a kill candle, then you will miss out on potential profits gained.
What's the optimal trail?: We get asked this question a lot. Maybe one of you intelligent individuals can figure it out. What is the optimal trail 0.05, 0.10 or higher? Optimal meaning it prevents you from getting stomped out when price continues in your direction.
Overall:
Securing profits is THE MOST IMPORTANT PART of options trading.
There will always be trades you cut too early that go much higher, securing your profits means protecting your trading account so you will be there the next time!
When to set a trailing stop loss
We like to secure profits when the "easy part" of the move has completed aka when the price action stalls.
Securing profits can mean selling the full position or setting the trailing stop for a certain number of contracts so that you can have "free runners".
Price action will typically stop in one of three places:
At the strike (even dollars for 0DTE and various for stock flow)
At the blue line (the open price is a perfect place for a reversal)
At 3-strikes above or below the blue line (3-strikes is the average move intraday)
You should start by taking profits at each of these levels.
The only time we expect / anticipate price action to go beyond 3-strikes is when volume is over 120%.
Here's an example from SPY on 3/12/24.
We trade the BULL BOMB for the 511 call because it's 3-strikes down (advantage for bulls).
Price hulks through 512, so we hold.
Price hulks through 513 and there's a BULL bomb, so we hold.
Price hits the blue line and starts to come down, time to protect the gains with a trailing stop loss 0.05 and go to runners.
Result:
The max gain for this option contract is over 200% if held until the end of the session. Obviously we had no idea this would happen at 9:46am but we were able to secure out profit and take runner contracts (free) to over 100% returns.
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