This tutorial explains how to manage the risks involved in trading options through the analysis of risk management tools such as trailing stop orders and trailing stop limit orders. In particular, this article is focused on:
Trailing stops mechanics;
How to place trailing stops in ThinkorSwim;
How to set trailing stop orders at the market;
How to set trailing stop limit orders;
Moc and Loc orders’ mechanics.
By the end of this article, you should understand the mechanics behind trailing stop orders and how to place trailing stop at the market and trailing stop limit on your own. For further details about how to place common stop orders and stop limit orders, please visit Options Risk Management and Stop Losses – How to Place Stop Orders and Stop Limit Orders.
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Understanding Options Trading Potential
Trailing Stops Mechanics
The so called trailing stops are tools used by investors worldwide to maximize their profits, while reducing stress and anxiety about price fluctuations in the market. They are meant as stop orders that dynamically chase the stock price at a certain distance being automatically adjusted when the mark price moves in a favorable direction.
In other words, if you are long (bullish) on a position and set a trailing stop at $0.50 below the stock price, the trailing stop will start following the stock as it rises above $0.50. When and if the stock starts decreasing, the trailing stop will get stuck at the exact distance of $0.50 and there may be two different scenarios:
The stock drops at or below the dynamic stop at less $0.50; an order to sell will be automatically submitted.
The stock drops say $0.45 without touching the stop and then starts again its uptrend; in such case nothing happens and the trailing stop will start again chasing the stock price as it rises at a distance of more $0.50.
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On the other hand, if you are short (bearish) on a trade and a trailing stop is set at $0.50 above the stock price, the trailing stop will start chasing the stock as it falls below $0.50. When and if the stock turns around going upward, the stop will get stuck at the exact distance of $0.50 and the two following scenarios may occur:
The stock rises at or above the dynamic stop at more $0.50; an order to buy back the stock will be automatically submitted.
The stock rises say $0.45 without touching the stop and then starts again its downtrend; in such case nothing happens and the trailing stop will start again chasing the stock price as it decreases at a distance of more $0.50.
Let us make it easier with an example. Imagine that after having purchased 1000 shares of Microsoft Corporation (MSFT) at the price of $30, it experiences a strong uptrend touching the target price of $36 after a few months. At this point, you may want to offset your position by selling back the shares and getting a 20% profit or you may also decide to set an automatic trailing stop at say $1.00 below the stock price. The latter option allows you to benefit from a further increase in the price of the stock (potentially unlimited), while limiting your risk on the downside.
Trailing stops can be set either at the market or as limit orders. In the first case, once triggered the order will be surely executed, but it is not guarantee the price at which your order will be filled. Conversely, in the second case, the execution of the order is not guarantee, but if filled, the price you get is certain.
How to place trailing stops in ThinkorSwim
In order to perform trailing stops in ThinkorSwim, go straight to the “trade” tab on the top left corner of the software and select the “all products” section. Type in the “symbol” box the ticker you are interested in. For instance type in the Microsoft Corporation ticker (MSFT) and click enter.
Down below the “symbol” box, a menu will pop up with the three following options: underlying, trade grid, options. Focus on the menu underlying in which are contained all the information related to the stock. Keep in mind that in the ThinkorSwim platform you can generate a buy order by clicking on the asking price and a sell order by clicking on the bidding price.
Left click on the asking price and the “order entry tools” window will pop up down below with the order to purchase shares of stocks. In this window, the “order” menu on the heading right side is set by default as a limit order. Click on the option “limit” and a drop-down menu will pop up with several different types of orders you can choose from: market, limit, stop, stop limit, trail stop, trail stop limit, moc, and loc.
How to set trailing stop orders at the market
Select the trailing stop order (trailstop) from the drop-down menu so that a second line pops up in the “order entry tools” window. At this point, in the “price” section of your order you should read the following information:
Order at the market (MKT);
Trailing stop price (TR).
The trailing stop can be set as a value, a percentage, or a tick by clicking on the small rectangle on the left of the “price” section. The choice amongst these units of measurement depends only on the kind of financial instrument traded. Personally, I simply utilize the first option named “value offset” that stands also as the industry default.
In addition, you must choose a link between the underlying price and your trailing stop. Look at the “link” section on the order entry and select the value “last” on the drop-down menu right there. With the link in place, set the “value offset” at the desired distance from the stock price and then confirm the order.
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For example, imagine purchasing 100 shares of MSFT at $25 per share and placing a trailing stop order below $1.00. In this particular case, just type in +1.00 from your keyboard and click enter to place your order to sell back 100 shares of MSFT at the market. A word of caution is necessary at this point. In fact, the trailing stop is going to work only after MSFT has raised $1 to the amount of $26 (that is why you must digit +1.00 as trailing stop).
From this moment your stop will be triggered, meaning that it will be automatically submitted if the stock price drops $1 or more at any time in the future. For this reason, you must also think of setting a stop order so as to limit your losses in case the stocks turned against you from the outset. After the trailing stop is triggered, then you may cancel that stop order.
Bear in mind that placing a trailing stop at the market guarantees that your order will be filled once executed, but it does not guarantee the price at which your order will be filled.
How to set trailing stop limit orders
Select the trailing stop limit order (TrailStopLimit) from the drop-down menu and a second line will pop up in the “order entry tools” window. In this case, the system will ask you the limit price at which you want your order to be submitted. Here comes the point that differentiates the most this kind of order from a normal stop limit.
As a trailing stop order is for its nature a dynamic order, it would be a nonsense trying to set manually an exact limit price. For this reason, you must establish a connection between the limit price and the trailing stop. In order to do so, click again on the “link” section on the order entry and select the value “last” also for the LMT line.
Then set the limit price in a way that matches the trailing stop trying to type in a value slightly lower so as to allow you some room in case the underlying price may be falling very quickly when the trailing stop price is reached. In the previous example, you may consider setting your trailing limit order at +0.80.
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The decision of choosing between a trailing stop order (TR – MKT) and a trailing stop limit order (TR – LMT) depends mainly on whether you wish or not to hold the shares.
If you would rather get out from your position at any cost when the trailing stop is touched regardless of the price choose a trailing order at the market, instead if you would prefer to hold your position pick a limit trailing order.
Bear in mind that placing a trailing stop limit order guarantees the price at which you get filled, but actually it does not guarantee the execution of the order.
Moc and Loc orders mechanics
ThinkorSwim gives you the ability to place two additional kinds of orders: Moc and Loc orders.
A “Moc” order allows traders and investors to place an order at the current market price just before the closing bell. This order, which is guaranteed to be filled, can be useful with options in order to close out your credit spreads at the expiration date getting all time value.
A “Loc” order allows traders and investors to place a limit order at a certain price or better just before the closing bell.
Flavian Barrett is a self-made stock options trader who is dedicated full time to options trading. He has spent several years mastering the art and science of advanced options strategies and concepts such as options pricing and volatility, greeks and time decay.
In his website www.FromZeroToOptions.com he shares tips, techniques, tutorials and insightful articles and resources options related.
If you want to get instructions on how to place the most rewarding options strategies from scratch! .. go to Options Strategies – The eBooks.