The 7% - 8% cut loss rule seems OK for stock purchases, is it also equally applicable for Options? (October 23, 2000)
We don't use that for options for several reasons. One is the larger spread that you have to overcome. If you calculated 8% from your buy point, a big chunk of that could be eaten up by the spread between the bid and the ask. We prefer to use a loose 25% loss cutting rule, but because the option market is a bit wilder and looser than stocks alone, we will let an option fall below 25% at times. We use pre-set stop losses, but we do so mostly with very liquid options, i.e., well over 100 open interests. Otherwise, if you put in a stop loss order on options that are not very liquid, you get jumped over and taken out at a lower level. A stop limit might work better, but you have to have a trade to activate it, and again you could be passed right over. Thus we prefer very liquid options positions. If we have a long term option and we are getting the right price/volume action, we will ride an option position below 25% of the price, but we never let them go below 50%.
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