Risk Management - Stop Orders

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Risk Management - Stop Orders Stop-loss Orders An order that becomes a market sell order when the security trades at or below the price specified in the stop-loss order (trigger price).

1 Risk Management - Stop Orders Stop-loss Orders An order that becomes a market sell order when the security trades at or below the price specified in the stop-loss order (trigger price). Stop Loss Limit Order A stop loss limit order is slightly different than the stop loss market order. When stop limit order type is selected both a stop price and the limit price is entered. Once the stop price is reached, the brokerage will execute a limit order at the predetermined limit price. Trailing Stop What about the scenario where the stock price is rising, you want to let the stock run, but you don t want to give back all your gains in case the stock starts to turn over. In this case, you can use what s called a trailing stop order which will set a stop order when your position falls a certain percentage or dollar amount. The trailing stop will set a new stop price as the stock rises, but will trigger the order if it falls by the stop percentage or amount. Risk Control 101, presented by Greg Shtock. Web site: 1

2 Bracket Orders Bracket orders are designed to help limit your loss and lock in a profit by "bracketing" an order with two opposite-side orders. A BUY order is bracketed by a high-side sell limit order and a low-side sell stop order. A SELL order is bracketed by a high-side buy stop order and a low side buy limit order. Risk Control 101, presented by Greg Shtock. Web site: 2

Warning: Stop Loss Order Does NOT always protects you!!! If you had stop loss orders on May 6 2010 or on April 23, 2013, you would be stopped out at significant lose! Why?

3 Warning: Stop Loss Order Does NOT always protects you!!! If you had stop loss orders on May or on April 23, 2013, you would be stopped out at significant lose! Why? Two notable flash crashes have occurred at that time. A flash crash is a very rapid, deep, and volatile fall in security prices occurring within an extremely short time period. A flash crash frequently stems from trades executed by black-box trading, combined with high-frequency trading, whose speed and interconnectedness nature can result in the loss and recovery of billions of dollars in a matter of minutes and seconds. The first event occurred on 6 May 2010 when a $4.1 billion trade on the NYSE, resulted in a loss to the Dow Jones Industrial Average of over 1000 points and then a rise to approximately previous value, all over about fifteen minutes. The second event occurred on April 23, 2013, a Twitter account was hacked to release a hoax tweet about fictional attacks in the White House that left President Obama injured. This erroneous tweet resulted in a brief plunge of 130 points from the Dow Jones Industrial Average, removal of $136 billion from S&P 500 index. Risk Control 101, presented by Greg Shtock. Web site: 3

4 Risk Management - Protective Put Option Put Option is a contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time. The protective put, or put hedge, is a hedging strategy where the holder of a security buys a put to guard against a drop in the stock price of that security. A protective put strategy is usually employed when the options trader is still bullish on a stock he already owns but wary of uncertainties in the near term. It is used as a means to protect unrealized gains on shares from a previous purchase. Protective Put Payoff Diagram Risk Control 101, presented by Greg Shtock. Web site: 4

5 The Collar Strategy A collar is an options trading strategy that is constructed by holding shares of the underlying stock while simultaneously buying protective puts and selling call options against that holding. The puts and the calls are both out-of-the-money options having the same expiration month and have equal number of contracts. Collar Strategy Construction: Long 100 Shares, Sell 1 OTM Call, Buy 1 OTM Put The collar is a good strategy to use to reduce the protective put option cost. It is also used by options traders writing covered calls to earn premiums but wish to protect himself from an unexpected sharp drop in the price of the underlying security. Collar Strategy Payoff Diagram Risk Control 101, presented by Greg Shtock. Web site: 5

Risk Management Trading Plan. Rogers Communications, 4.3% Dividend, Uptrend see blue support line, fundamentals are o.k. Before you invest in this stock, you MUST have a plan.

6 Risk Management Trading Plan. Rogers Communications, 4.3% Dividend, Uptrend see blue support line, fundamentals are o.k. Before you invest in this stock, you MUST have a plan. If you fail to plan, you plan to fail! Risk Control 101, presented by Greg Shtock. Web site: 6

7 Example: Investment Plan, Rogers Communications. Investment Plan: Buy at $43.02, Stop Loss at $42.37, Profit Target $48.06 Risk Control 101, presented by Greg Shtock. Web site: 7

8 Investment Plan: Buy at $43.02, Stop Loss at $42.37, Profit Target $48.06 Risk Management, Position Sizing Remember, never put all your eggs in one basket. You need to spread your investments across various investments in your portfolio. Decide how many position you want to have. For example, if you decided to have ten different positions in a $100,000 portfolio, you should buy only $10,000 of Rogers stock. This means, your maximum position could be only $10,000 / $43.06 = 232 shares. Lets use rounded number of 200 shares. Risk Management, Maximum Loss If you buy at $43.02 and the stock goes down, you sell at $42.37, which is your stop loss. Therefore, your loss would be $ $42.37 = $0.65 per share or total amount of 200 shares x $0.65 = $130. You must accept the fact that you may lose $130 on this investment. Risk Management, Risk / Reward Ratio The target price in your plan is $ Therefore, you potentially could make $ $43.02 = $5.04 per share. Potential profit would be 200 shares x $5.04 = $1,008 The reward vs. risk ratio is $1008 / $130 = 7.7 Let say that on average, half of your investments are losing money. If you have 7:1 reward to risk ratio, you will be making money even if 50% of your investment decisions were wrong. Risk Management is very important!!! Risk Control 101, presented by Greg Shtock. Web site: 8

9 To download or read this presentation go to this website: Risk Control 101, presented by Greg Shtock. Web site: 9

Finance 527: Lecture 30, Options V2

Finance 527: Lecture 30, Options V2 [John Nofsinger]: This is the second video for options and so remember from last time a long position is-in the case of the call option-is the right to buy the underlying