Before you can even be comfortable getting in and out of orders you have to know what tools you have at your disposal. That's what I'm going to cover here.
Getting into a position – The basics
There are really only 2 basic order types to establish an options position.
A market order executes at the current market price. No bargains here, just quick entry at the next available price.
A limit order executes a trade at a particular “price” or better that you set. The price is manually entered by the investor, and if it is not met, the order does not fill.
When trading options, you either buy-to-open (BTO) or sell-to-open (STO) a position. Conversely, you will buy-to-close (BTC) or sell-to-close (STC) to exit the position.
Getting into a position – Advanced techniques
For more advanced traders, there are other options (no pun intended). Even though these may seem more advanced, they really aren't once you know how they work.
A stop-limit order executes the order when the investor's price is hit, but limits how high to buy, or how low to sell. This is another great risk management technique, but you could miss your trading window entirely if the price moves too quickly.
A trailing stop order adjusts with the market price, and “trails” it by a certain specified percentage or amount that you set. This type of order leaves the trader poised to take advantage of sudden market corrections.
A trailing stop-limit order allows the trader to specify a cap on the possible loss, without capping a possible gain. This is the best of both worlds, but again you risk completely missing the entry if the market moves too fast. Not my personal favorite.
Exiting an options trade correctly
There are three traditional ways of exiting an options position. Exercise the position, allow the position to expire worthless, or offset it. Most traders choose the later and reverse the order to close, just like they traditionally do with stocks. But you don't always have to go that route.
The quickest way to close out your position is to enter the offsetting order with a market price.
Simply put, this means that you sell a stock option that you have already purchased to someone else at the closest price available. In a fast moving market this can help save thousands of dollars. However, market orders do not guarantee the best price possible.
Pennies add up!
There are great opportunities in the world of options trading, but only if you continue to focus on the details. Entering and exiting an options trade properly, with minimal slippage, takes advanced planning and foresight.
Know what you are getting into from the start and do your homework now. It will pay big dividends down the road!
FAQs
What is buy-to-open vs. sell-to-open?
Buy-to-open (BTO) and sell-to-open (STO) are used to initiate new positions. Buy-to-open orders are used to purchase a call or a put. Sell-to-open orders are used to sell a call or a put.
What happens when you sell-to-close an option?
Sell-to-close (STC) orders are used to close positions that originated from a buy-to-open (BTO) order. For example, if a long call was purchased to initiate a trade, it will need to be sold to exit the position. Once the sell-to-close order executes, the position is no longer held in the account.
How do you close a sell-to-open?
To exit a position that was initiated with a sell-to-open (STO) order, a buy-to-close (BTC) order is used. For example, if a short put was sold to enter a trade, it will need to be purchased to exit the position.
