|
The
covered call writer should have a stop loss
set on every position taken. The stop loss can be a mental
one, or can be entered as a trade order with the broker,
if the broker allows it; not all do. Such a trade order
is known as a sell stop order. Entering
a sell stop order on a long stock position is easy; you
enter it as a stop price or stop limit. There is no way
to enter a true sell stop order on covered calls, however,
because the order as to the underlying stock must be entered
with the stock exchange or market maker, and as to the short
calls must be placed with the options exchange. A trader
cannot set a stop on a covered call position by entering
a stop order only on the stock, since the broker will not
be willing to sell the stock and leave the call naked (unless
the account is approved for naked call writing). Thus if
the broker does sell the stock out of a covered call position
and the writer is not approved to write naked, the broker
must immediately buy back the calls at market; the broker
will not allow the writer to be naked for more than an instant.
Merely
buying back the short calls to close is no help if the trade
is in trouble, since the danger is in the underlying stock,
not the short calls.
Similarly,
there is no practical way to set a stop on a covered call
position based on the call’s price, since calls lose
value very differently depending on changes in delta and
whether the call is ITM, ATM or OTM. An ITM call may lose
value dollar-for-dollar with the falling stock, or may not.
An OTM call can hold onto its premium to an astonishing
degree as the stock tanks. Thus any effective sell stop
order for a covered call position must be based on movement
in the underlying stock’s price.
The
solution is to put in an OTO (one triggers
other) order with the broker, specifying
that if the stock reaches a certain price, the broker is
to sell the underlying stock and buy back the calls. While
the sell stop on the stock is essentially a limit order,
the broker will not allow a limit price on the buyback of
the calls, as noted above, unless you are approved for naked
call writing – the short calls will be bought to close
at market. Not every broker allows an OTO, because the broker’s
trading platform software must be programmed to allow it.
In fact, many brokers don’t - for example, InteractiveBrokers.com
is highly rated for its extremely low trading costs but
does not allow entry of a stop order. Two excellent online
option brokers that do allow OTO orders are www.optionsXpress.com
and www.ThinkorSwim.com.
There
is yet another way to effect a covered call sell stop order.
As we discussed above, virtually every broker allows entry
of a limit order in the form of a “net debit”
order to put on a covered call trade. And the reverse is
true: it is possible to close a covered call trade with
a net credit order. Thus you can, at any
time after opening a position, enter a closing order that
specifies a net credit as the limit. As with the OTO order,
check with your broker for order availability. Both optionsXpress
and ThinkorSwim
allow closing net credit orders.
The
sell stop order is highly recommended for traders unable
to monitor a trade, particularly when on vacation and such.
If unable to enter a stop order, the only alternative is
to employ a "mental stop" (entered only in your
head) and monitor the trade.
Online
Option Brokerages
Question:
Does CallWriter recommend any particular online option
brokers? It is difficult to tell much about them from their
websites.
Answer:
There are many online brokerages that trade options. Having
said that, just because a brokerage runs option trades does
not mean that they are a competent or desirable options
broker, and many aren't very good for options. While all
brokers handle transactions in stocks and perhaps other
derivatives, we prefer options brokers that have decided
to specialize in the options end of the market. Building
a platform that will handle complex options trades is a
huge undertaking, and not all "options brokers"
have done it. The two firms we have the highest regard for
(this by no means is meant to imply that other brokers are
deficient) as options brokers are the two mentioned above:
optionsXpress and ThinkorSwim. They also seem overwhelmingly
popular with our membership. OptionXpress's software is
web-based; ThinkorSwim's must be downloaded onto your computer.
Each approach has its advantages and disadvantages, but
take it into consideration in choosing a broker.
optionsXpress:
optionsXpress provides some pretty innovative securities
brokerage products and services for investor education,
strategy evaluation and trade execution. They offer a wide
range of investor tools, licensed customer service and competitive
commissions, and do not charge extra for help from a live
broker, should you need it. They pioneered the use of customized
order-entry screens for every different options strategy.
One feature that new traders particularly like is optionXpress'
virtual trading (aka "paper" or "phantom"
trading) feature, which customers can use upon opening an
account, even if it has not been funded. For a website with
such vast offerings, it is amazingly simple and easy to
use; it is a model of excellence in website design. optionsXpress
earned 4 1/2 stars from Barron's (the #1 ranking) 3 years
in a row, and Forbes' named optionsXpress a Best of Web
"favorite" site. See Barron's
rankings of web-based brokers.
thinkorswim:
TOS does not charge its customers for its software (which
they believe to be the best in the business), and they allow
customers to access their institutional trade desk for assistance
with trades at no additional charge - most firms charge
significantly more if a human broker becomes involved. TOS
is staffed with former traders and brokers from the floor
of the CBOE with 5 to 25 years' experience. Barron’s
has rated TOS #1 in execution for the last
2 years. Finally, TOS says that it is the only major firm
that does not accept payment for order
flow from exchanges or market makers. TOS is offering
a couple of promotions. TOS will send customers a 39.95
check for each month in which the customer makes 40 or more
trades, and for persons switching their accounts to TOS
from another firm, TOS will pay the cost of transferring
stocks over up to $100, and will even pay for the transfer
back if the customer is unhappy. See the TOS
brokerage comparison.
|
