Automating exit strategies for options trades

E*TRADE from Morgan Stanley

 06/06/23

In an options trade, a well-thought-out plan can make all the difference, and a key part of that plan to consider should be your exit strategy. Setting a pre-defined strategy on the closure of a position can help you better control the outcome of your trades, as well as prevent emotional decisions -- which may limit risk and potentially lock in a desired profit.

In this article, we take a closer look at the variety of ways in which you can use the tools available at E*TRADE to create your own exit strategy. Specifically, we’ll explore how you might be able to use conditional order types to automate the entry of closing orders. A closing conditional order can be entered any time after the opening of a position, and will remain queued until the pre-defined closing criteria is reached, at which point the order will trigger the entry of a market or limit order to close your position.

Let’s explore three potential exit scenarios based on price conditions and how to facilitate them on E*TRADE platforms. Each example covered will be illustrative of using a conditional order type to automate a closure of a long position.

1. Exit an options position based on the price of the underlying via a contingent order

A contingent order lets you place a closing options order automatically when a condition you set for the price of a stock, option, or index is met.

 

Here’s an example:

  • Let’s say you’ve purchased a call option based on a stock’s move off a recent low of $125.
  • You plan to hold the options position as long as the stock remains above $125; if the stock’s price drops below this threshold, you plan to exit your long call position—regardless of the option’s value at that time.
  • You’ve created an alert to notify you when the underlying is at this level so you can manually enter the closing order; however, you’re worried that you could miss the alert—thus missing the exact market scenario for which you planned your exit strategy.
  • To help you avoid this, you can consider:
    • Employing a conditional order type that will automatically trigger only if the desired underlying price condition is met. Once triggered, it will automatically enter a market order to close your options position.

How-to on E*TRADE

This closing strategy is implemented by entering a contingent order on etrade.com in the Conditionals section of the Trading tab.

As seen in the example order ticket below, the entry of a market order to close the options position is contingent on the underlying stock price and will trigger when the last price is less than or equal to $124.99. If this price contingency occurs, then the market order will automatically be entered, selling to close a long call position “at market” price, meaning the best price that is available at that time.

Please note that a market order execution price can substantially deviate from the quoted price displayed when the order was entered. This is particularly the case in times of extreme or heightened volatility of the security, limited liquidity, or a delay in order vetting, handling, or routing. For more information on the risks associated with market orders, click here: Understand order types.

 

How-to on Power E*TRADE

This closing strategy is implemented through a feature found on the Power E*TRADE platform called “Quote Trigger” in the Automation section of the order ticket.

As seen in the example order ticket below, the entry of a market order to close the options position is contingent on the underlying stock price and will trigger when the last price is less than or equal to $124.99. If this price contingency occurs, then the market order will automatically be entered, selling to close a long call position “at market” price, meaning the best price that is available at that time.

Please note a market order execution price can substantially deviate from the quoted price displayed when the order was entered. This is particularly the case in times of extreme or heightened volatility of the security, limited liquidity, or a delay in order vetting, handling, or routing. For more information on the risks associated with market orders, click here: Understand order types.

 

 

 

 

 

2. Exit an options position based on a dynamic dollar value using a trailing stop order

Trailing stops are a unique form of conditional order where the trigger automatically adjusts as long as the price moves in a profitable direction– but if the price moves unfavorably, the stop price freezes and the order to close is triggered. This type of trade is a dynamic (i.e., moving) stop loss order that uses a predetermined dollar value that is a fixed “trail” amount away from the current market price, as opposed to a specific price. In the case of a sell trailing stop order, if the market moves up the stop price follows by the trail amount—but if the price declines, the trailing amount and stop price will never move downward. If the market declines through your current stop price, this triggers the execution of the trade, and a market order will be submitted to close the position. This type of order is designed to limit losses as the price of the security moves and lock in potential profits when the price of a security reaches the trailing stop price. For information on the risks associated with trailing stop orders, click here: Understand order types.

 

Here’s an example:

  • You want to close out of a call position while attempting to maximize your profit potential and protect yourself if the price falls. 
  • You do not want to cap your profit potential by establishing a concrete exit price in a stop order and would prefer the stop price to be dynamic and follow the market movement.
  • You can consider:
    • Employing a trailing stop order to “trail” the market price of the security as it moves upward, potentially locking in profits as the price moves. Only when the market changes direction and falls through your stop price will the market order be triggered and entered into the system.

How-to on E*TRADE:

This type of conditional order is set up on etrade.com via the Options subtab within Trading. As seen in the example order ticket below, Trailing Stop $ is selected as the price type, with a stop value of $2. The current bid price of the call is $5.40. The stop price will start at $3.40—$2 lower than the current price.

If the price were to rise to $7, the stop price would trail accordingly to $5, $2 below the new high. If the bid price of the call option were to rise 10 points to $17, your stop price would trail along, up to $15.

As long as the market price continued to rise, your stop price would keep trailing upward, $2 below market price. If the price peaks at $17 but begins to fall and reaches your most recent stop price of $15, your closing order would be triggered and a market order to close your position would be entered into the system. For information on the risks associated with market orders, click here: Understand order types.

If the trailing stop order had not been in effect, you might not have closed the position at the peak high before it fell substantially, losing the opportunity for potential profit.

 

How-to on Power E*TRADE

This type of conditional order is set up on the Power E*TRADE platform directly in the order ticket. As seen in the example order ticket below, Trailing Stop $ is selected for the price type, with a stop value of $2. The current bid price of the call is $5.40. The stop price will start at $3.40—$2 lower than the current price.

If the price were to rise to $7, the stop price would trail accordingly to $5, $2 below the new high. If the bid price of the call option were to rise 10 points to $17, your stop price would trail along, up to $15.

As long as the market price continued to rise, your stop price would keep trailing upward, $2 below market price. If the price peaks at $17 but begins to fall and reaches your most recent stop price of $15, your closing order would be triggered and a market order to close your position would be entered into the system. As noted above, for information on the risks associated with market orders, click here: Understand order types.

If the trailing stop order had not been in effect, you might not have closed the position at the peak high before it fell substantially, losing the opportunity for potential profit.

 

 

 

 

3. Exit an options position based on either a loss or gain scenario using one-cancels-other (OCO) order

Using a risk/reward ratio is a common approach to a closing strategy, where you may be willing to risk $1 while hoping to capture a $2 reward. Some options traders may take a similar approach where they will close out a position if they double their money or if they have suffered a loss of 50%. In this scenario, the goal is to accomplish two things:

  • Reduce your downside risk
  • And potentially lock in market gain

You can do this by setting simultaneous conditions to exit an options position if the maximum acceptable loss is reached or if the profit goal has been reached. Both of these conditions can be accounted for and combined into one conditional order type known as the one-cancels-other, or OCO order.

What makes this order type unique from other conditionals is that both sides of the order are submitted and are pending until one of the conditions is met. If one of the conditions is met, the corresponding side of the closing order will be triggered, and the other side will be canceled. This will help you to only sell the number of contracts you have or wish to sell.

How-to on E*TRADE

An OCO order is created from the One-Cancels-Other template, located in the Conditionals section of the Trading tab on etrade.com.

 

Here’s an example:

  • You have purchased a long call for a price of $2 and have determined that you have a 100% profit goal and 50% maximum loss threshold.
  • You would like the position to be closed when either condition is reached: a 100% increase in value to $4 OR a loss of 50% to $1.
  • If one of your desired conditions is met triggering the corresponding closing order, you would like the other order to be canceled.

To build this order, two trades are included within the OCO template: one accounting for the profit condition, the other for the loss condition.

  • Step 1: Set up the profit condition
    • Select an Options ticket type, selling to close the desired position.
    • Input your 100% goal profit amount of $4 limit price.
  • Step 2: Set up the loss condition
    • Enter the second half of the order, selling to close the desired position.
    • Input your 50% maximum loss value of $1.
  • Step 3: Submit the order
    • Both the profit and loss threshold closing orders will be pending and automatically execute if either 100% profit or 50% loss conditions are met.

Upon one condition being met, the remaining order will be canceled.

 

 

How-to on Power E*TRADE

An easy way to set up an OCO order is to use the Exit Plan tool on the Power E*TRADE platform. Exit Plan facilitates the input of profit target prices and stop loss prices, which will then be automatically translated into a OCO order template.

 

Here’s an example:

  • You have purchased a long call for a price of $2 and have determined that you have a 100% profit goal and 50% maximum loss threshold.
  • You would like for the position to be closed when either condition is reached: a 100% increase in value to $4 OR a loss of 50% to $1.
  • If one of your desired conditions is met triggering the corresponding closing order, you would like the other order to be canceled.

To build this order, two trades are included within the Exit Plan template: one accounting for the profit condition, the other for the loss condition.

  • Step 1: Select the option you wish to close from the Positions list and follow the Exit Plan parachute icon
  • Step 2: Setup the profit condition. Click the arrow up button on the profit target input box until the % Change from Cost value reaches 100%.
  • Step 3: Set up the stop loss condition. Click on the down arrow button until the % Change from Cost is at -50%.
  • Step 4: Click Create Order. The OCO order template is automatically prepopulated in the next screen with the prices accounting for the 100% profit and 50% loss thresholds selected.
  • Step 5: Preview and submit the order. Both the profit and loss threshold closing orders will be pending and automatically execute if either 100% profit or 50% loss conditions are met. Upon one condition being met, the remaining order will be canceled.

­­­­This order type can also be set up manually, but the Exit Plan tool helps you to simplify the order entry process and provides information such as cost basis, dollar and percent change from cost values, and the market gain and loss amounts.

 

 

 

 

 

 

Key takeaways

When you consider building a trading plan in advance, your trading is less likely to be influenced by emotion—and more influenced by data. Part of that trading plan is to establish at what point you wish to close a position. Using conditional order types to trigger a closing order based on predetermined conditions such as the price of the underlying security or on profit/loss thresholds being met may be a helpful method for you to consider that can save time and provide freedom from constantly monitoring the market and entering orders manually.

The conditions you specified for your exit strategy may not occur—but if they do, automating your orders can help you capture the opportunity to limit risk and potentially lock in a desired profit.