Is a 10% STOP on ATM Options a Good Idea?

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In today’s video, I want to share with you some insight on a 10% stop for at-the-money options. Can that be right? Is that where you should stop out? That’s the question for today, which someone in a Facebook group asked. I thought it’s a good question to make a video on. So, is a 10% trailing stop right for near-the-money options like SPY? If not, what do others use?

First off, the question doesn’t state if they’re buying or selling or if they’re doing vertical spreads or those kinds of things. I’m going to assume they are buying single options. It could also be buying at-the-money vertical spreads. The reason I’m assuming this is because there’s not a lot of context, and this is what most people do from a commonality perspective.

10% Stop for At-the-Money Options

Single Options

Let’s talk about buying single options, especially for things like QQQ or SPY. I will say in most cases, if you’re doing an at-the-money option spread or near at-the-money, a 10% stop is generally very tight. For example, let’s say I buy a QQQ option for $584. A 10% stop means you would stop out if the value drops by $58.

With options, especially those close to expiration, they decay quickly. The Theta (time decay) for an at-the-money option could be around $28 per day. So, within two days of no movement, you could already be down $56, nearly hitting your 10% stop. This tight stop might cause you to get stopped out frequently, reducing your chances of a profitable trade.

Comfort with Full Loss

When buying options, especially near-the-money ones, you should be comfortable with the full potential loss. For example, if you’re buying an option for $584, you should be okay with losing all $584 if the trade goes against you. If not, you’re probably trading positions too large for your account size.

Vertical Spreads

To mitigate some of the decay risk, you could consider doing vertical spreads. For example, if you do a $2 wide vertical spread, you might be risking $100 to make $100. This setup gives you a clearer risk-reward profile and can be more manageable. Again, you need to be comfortable with the full potential loss of the vertical spread.

Alternative Strategies

If single options and vertical spreads are too complex or risky, you might want to consider trading cheaper options. For instance, instead of QQQ, you could look at options for less expensive stocks like Ford. Buying a cheaper option means you risk less capital, and you might not need as tight of a stop.

Mitigating Theta Decay

One way to mitigate Theta decay is to sell options against your long position, creating a spread. For instance, if you buy a call option, you could sell a put option to offset some of the time decay. This strategy requires a good understanding of options and might not be suitable for beginners.

Conclusion

In summary, a 10% trailing stop for near-the-money options can be very tight and might lead to frequent stop-outs, especially with high Theta decay. It’s essential to understand how options work and to be comfortable with the full potential loss. If you find a 10% stop too tight, consider adjusting your position size or exploring alternative strategies like vertical spreads or trading cheaper options.

I hope this was helpful. If you have more questions or want to join our Facebook group, check out the link below. There’s a lot of great content there, and I regularly answer questions. Also, check out the free resources and training we offer on our website. Thanks for joining me, and I’ll see you in the next video. Take care.

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