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Tips of the TradeLearn how to use the many different order types available at Scottrade. Watch our Order Types Tutorial today for a detailed guide through market, limit, stop, stop limit, trailing stop, conditional, one cancels all (OCA) and one cancels other (OCO) orders.
Options traders typically keep an eye on volatility because of the sizable impact this measure has on the premiums of their contracts. If volatility increases, all else equal, option prices will increase, and vice versa if volatility declines. OptionsFirst offers a tool called Volatility Charts to help option traders keep track of this important aspect of pricing.
This tool gives the trader the flexibility to compare historical volatility against implied volatility going back up to a year in the past. This allows traders to see if the current option markets are over or underpriced compared to historical volatilities. It also compares call vs. put volatilities to help identify market biases.
This tool is available exclusively on the OptionsFirst trading platform. To access it, click the Tools tab at the top of your OptionsFirst account, look for the Vol Charts module in the right column, and click Launch Tool. Visit www.options.scottrade.com to learn more.
Options involve risk and are not suitable for all investors. Detailed information on our policies and the risks associated with options can be found in the Scottrade OptionsFirst Options Application and Agreement, Brokerage Account Agreement, and by downloading the Characteristics and Risks of Standardized Options and Supplements (PDF) from The Options Clearing Corporation, or by requesting a copy from your local branch office. Market volatility, volume, and system availability may impact account access and trade execution. Supporting documentation for any claims will be supplied upon request.
Stop & Stop Limit Orders for Beginners
By Kim R. Gibas, Senior Branch Manager, Delafield, Wis.
After writing Trading for Beginners in the April issue of KnowHow News, I wanted to take order placement a step further and discuss stop orders and stop limit orders.
Understanding Stop and Stop Limit Orders
Stop and stop limit orders are orders that have "price triggers" - they execute only when the stock reaches a certain price. These orders are most commonly used to protect a profit or limit a loss, which is why they are frequently referred to as "stop loss" orders. These orders can be used on both buy and sell orders. The buy order would typically be utilized for a short position and the sell order would typically be for a long position.
The "price trigger" placed for orders can be confusing to understand. I will first explain the sell side of stop and stop limit orders and then move to the buy side.
Using Stop and Stop Limit Orders on the Sell Side
For both stop and stop limit orders, the trigger price is set below the current price of the stock. Once the stop order is triggered, it turns into a market order and immediately executes. When the stop limit order is triggered, it turns into a regular limit order and its limit conditions apply.
Stop Order Examples on the Sell Side
Scenario 1 - Protecting a Profit
The investor bought 100 shares of XYZ at $10 per share, and the current stock price is $12.
Example: The investor places a stop order to sell 100 shares of XYZ at a stop price of $11 per share.
Strategy: The investor wants to capture a $1.00 per share profit in this stock if the price declines, and wants to continue to hold the stock if it rises or maintains its price at $12.
If the stock price falls to or below $11, the order will be triggered, and the stock will be sold as a market order at the next available price. This means that if the price of the stock goes from $11.50 to $10.50 without ever landing on exactly $11, for example, the order will still be placed. Passing $11 will trigger the order, and then the market order will be executed at the current market price of the stock.
If the stock stays above the $11 trigger price during the duration of the order, the order will not be triggered and the investor will keep the shares. This sell stop order would cost $7 online or $27 through your local Scottrade broker.
Scenario 2 - Limiting a Loss
The investor bought 100 shares of XYZ at $10 per share, and the current stock price is $9.
Example: The investor places a stop order to sell 100 shares of XYZ at a stop price of $8.50 per share.
Strategy: The investor is limiting his or her loss to about $1.50 per share should the stock drop significantly.
The stock drops to or below $8.50 and the order is triggered. The sale executes as a market order, which means the shares are sold at the next available price. Just like in the previous example, the execution price may or may not be exactly the same as the trigger price entered by the investor.
If the stock does not drop to or below the trigger price of $8.50 during the duration of the order, the order will not be triggered and the investor will keep the shares. This sell stop order would cost $7 online or $27 through your local Scottrade broker.
Stop Limit Order Examples on the Sell Side
Scenario 1 - Protecting a Profit
The investor bought 100 shares of XYZ at $10 per share, and the current stock price is $12.
Example: The investor places a stop limit order to sell 100 shares of XYZ with a stop price of $11 per share and a limit price of $10 per share.
Strategy: The investor wants to capture a $1 per share profit in this stock and is only willing to sell it at $10 per share or better.
The stock drops below $11, and the stop order is triggered. The order is now entered as a limit order with a limit price of $10. If the stock remains higher than $10 after the order is triggered, then the order will be placed. However, if the stock price were to gap down from $11 to $9.50, the order would not be placed. This is a risk with placing a stop limit order - limit orders do not guarantee that your order will be executed.
If the stock does not drop to or below the trigger price of $11 during the duration of the order, the order will not be triggered and the investor will keep the shares. This sell stop limit order would cost $7 online or $27 through your local Scottrade broker.
Scenario 2 - Limiting a Loss
The investor bought 100 shares of XYZ at $10 per share, and the current stock price is $9 per share.
Example: The investor places a stop limit order to sell 100 shares of XYZ with a stop price at $8.50 per share and a limit price of $8 per share.
Strategy: The investor is attempting to limit his loss to around $1.50 per share should the stock drop and is only willing to sell it at $8per share or better.
The stock drops below $8.50, and the stop order is triggered. The order is now entered as a limit order with a limit price of $8. If the stock remains higher than $8 after the order is triggered, then the order will be placed. Just like with the example above, it's important to remember that if the stock gaps down below your limit of $8, the order will not be placed.
This sell stop limit order would cost $7 online or $27 through your local Scottrade broker.
Stop Order Examples on the Buy Side
Scenario 1 - Protecting a Profit
The investor sold short 100 shares of XYZ at $10 per share, and the current stock price is $8. Selling short basically means you are borrowing shares from Scottrade in a margin account and selling them in the market. This is a strategy investors use when they believe the stock will go down and they will be able to purchase the shares, or "buy to cover", for less than they sold them. To learn more about selling short, visit the Knowledge Center.
Example: The investor places a stop order to buy back 100 shares of XYZ with a stop price of $9 per share.
Strategy: The investor wants to capture about $1 profit per share in this stock. In a short sale, the investor makes money when he can buy back the shares lower than the price at which he sold them.
If the stock rises to or above $9, the stop order will be triggered, and the buy order will execute as a market order at the next available price. Because the investor sold the shares short at $10, buying the shares to cover at any price lower than $10 will protect the investor's profit. Keep in mind, each transaction (selling short and then buying to cover) will cost a commission of $7, so that should be factored into the investor's breakeven point.
If the stock stays below $9, the order will not trigger and the investor will not purchase the shares in this transaction. This buy stop order would cost $7 online or $27 through your local Scottrade broker.
Scenario 2 - Limiting a Loss
The investor sells short 100 shares of XYZ at $10 per share, and the current stock price is $12.
Example: The investor places a stop order to buy back 100 shares of XYZ with a stop price of $13 per share.
Strategy: The investor is limiting his or her loss to about $3per share should the stock price rise any further.
The stock rises to or above $13, and the order is triggered. It will execute as a market order at the next available price. If the stock continues to rise above the investor's short sale price of $10, he will have limited his loss by buying the shares around $13.
If the stock stays below the investor's stop price of $13, the order will not be triggered and the investor will not buy back the shares. This buy stop order would cost $7 online or $27 through your local Scottrade broker.
Stop Limit Order Examples on the Buy Side
Scenario 1 - Protecting a Profit
The investor sold short 100 shares of XYZ at $10 per share, and the current stock price is $8.
Example: The investor places a stop limit order to buy back 100 shares of XYZ with a stop price of $9 per share and a limit price of $9.50 per share.
Strategy: The investor wants to capture about $1 per share profit in this stock and is only willing to buy to cover it at $9.50 per share or better.
The stock rises to or higher than $9, and the order is triggered as a limit order with a limit price of $9.50. That means that it will execute at the next available price as long as it is $9.50 or better. In the case of a buy order, "better" means lower than the limit price. Remember, with a limit order there is no guarantee that the order will execute.
If the stock stays below $9, the order will not trigger and the investor will not purchase the shares. This buy stop limit order would cost $7 online or $27 through your local Scottrade broker.
Scenario 2 - Limiting a Loss
The investor sold short 100 shares of XYZ at $10 per share, and the current stock price is $11 per share.
Example: The investor places a stop limit order to buy back 100 shares of XYZ with a stop price of $11.50 per share and a limit price of $12 per share.
Strategy: The investor is limiting his or her loss to about $1.50 per share should the stock price increase and is only willing to buy it at $12 per share or better.
If the stock rises to or above $11.50, the order will be triggered as a limit order with a limit price of $12. The order will be executed at the next available price as long as it is at or better than (below, in this case) $12. This ensures that if the stock keeps rising, the investor's losses will be limited.
If the stock does not rise to or above $11.50, the order will not be triggered and the investor will not purchase the shares. This buy stop limit order would cost $7 online or $27 through your local Scottrade broker.
Choosing the Right Price
For many investors, it can be difficult to remember whether to set the stop price, for example, above or below the current market price of the security. Limit, stop limit and trailing stop orders can be equally confusing. This chart may help you determine which strategy might work best for a given situation.
To read this chart, first decide whether you are buying or selling the stock. Then, depending on your order type, you will want to set your order to execute either above or below the current market price. So, if you want to set a buy limit order, you would set the limit price below the current price of the stock. To place a buy stop order, set the stop price above the current price of the stock.
Let's take an example. You own 100 shares of XYZ, and it is trading at $10, which is the market price. You bought at $12, so selling now would be a way to limit your losses if the stock drops any lower. If you decide to place a stop order, you would want to set the stop price lower than the current market price so that if it continues to fall, you will exit the position and sell your shares. So, the stop price you set should be lower than the current market price.
If you have questions about stop or stop limit orders, please contact your local branch office.
The strategies described in this article are for information purposes only and their use does not guarantee a profit. Investors should fully research any strategy before making an investment decision. Securities are subject to market fluctuation and may lose value.
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