Stocks and Commodities Magazine

Is it feasible to use a stop order when trading commodity options?

Is it possible to place a stop order on an option?

Electronic options on futures exchanges, likewise option trading platforms, do not accept stop orders on options. Some open outcry execution brokers might be willing to take the order by phone for execution in the pit, but in general stop orders on options are a thing of the past. With that said, even if it was possible to place stop orders on options it isn’t generally a good idea.

On the surface, the concept of having the ability to define approximate risk via stop order placement, similar to a futures trader, is appealing. Nonetheless, whether you are trading long or short options, the practice works much better in theory than it does in reality.

By definition, a stop order becomes a market order once the stated price becomes part of the bid (price you can sell) ask (price you can buy) spread. In other words, the order is elected once the price of the option, as determined by the spread between the bid and ask, reaches the stop price. Upon election of the stop order, the trade is executed at the best possible price available at that time.

The reason exchanges do not accept stop orders on options is because they are prone to excessive slippage at inopportune times. For instance, crude oil options rarely have market makers during the overnight session. As a result, the bid and ask of any particular option represents only those orders working by retail traders; in many instances the spread between the prices can be excessive. During such off market hours, it is not uncommon to see the spread between bid and ask in multiple dollars in premium (thousands of dollars in price).

 

Continue learning about commodity option stop orders in the March 2013 Stocks & Commodities Magazine

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