What is a "Stop Loss" in Options? (And Why It's Tricky)
Stop losses protect stock traders beautifully. In options? They often kick you out of winning trades. Learn why—and what to do instead.
Quick Summary
A Stop Loss automatically sells your position when it hits a certain price. In stocks, it's reliable protection. In options, wide bid-ask spreads and leverage-driven volatility can trigger your stop on "noise"—selling you out of winning trades. Many traders use mental stops based on the stock price instead.
In stock trading, the "Stop Loss" order is your best friend.
You buy a stock at $100. You set a Stop Loss at $95. If the stock drops, the computer sells it automatically, ensuring you never lose more than $5 per share. Simple, effective protection.
Naturally, new options traders try to do the same thing. They buy a Call Option for $2.00 and set a Stop Loss at $1.50.
But then, something frustrating happens. The option price dips to $1.45 for a split second, your Stop Loss triggers, and you're sold out of the trade. Ten minutes later, the option is back up to $2.50. You lost money on a winning trade. Why does this happen?
The Definition: What is a Stop Loss?
THE MECHANISM
A Stop Loss is a conditional order that becomes a Market Order once a specific price level (the "Stop Price") is reached.
"If Apple hits $140, sell my shares immediately at the best available price."
"If my Call Option hits $1.50, sell my contract immediately."
Why Stop Losses Are Tricky with Options
Options are not stocks. They have two characteristics that make standard Stop Loss orders dangerous.
1. The Bid-Ask Spread Trap
Stocks usually have a tight spread (e.g., Bid $100.00 / Ask $100.01). Options often have wide spreads (e.g., Bid $1.40 / Ask $1.60).
Spread Comparison
Typical Stock Spread
$0.01 (0.01%)
Typical Option Spread
$0.20 (10-15%)
You own an option
The "Last Traded Price" is $1.60. You set a Stop Loss at $1.40.
The market gets quiet
The Bid price drops to $1.40 simply because no buyers are around—even though the stock price hasn't moved.
Trigger!
Your Stop Loss sees the $1.40 Bid and fires. Your position is sold at market price.
The Damage
You're sold out at the bottom of the spread, just before the Bid bounces back to $1.50. You were "stopped out" by noise, not by a real price move.
2. The Volatility Whipsaw
Options are leveraged. A 1% move in the stock can cause a 20% move in the option. If you set a tight Stop Loss (e.g., 10% below your entry), normal market fluctuations will knock you out of the trade almost every time.
To use a Stop Loss effectively on an option, you'd have to set it so wide (e.g., -50%) that it often defeats the purpose of tight risk management.
The Better Alternative: Mental Stops
Because "hard stops" (automatic orders) are dangerous in options, many experienced traders use "mental stops" based on the stock price, not the option price.
Instead of this:
"Sell if the Option hits $1.50"
Use this:
"Sell the option if the Stock closes below $100"
- Why? The stock price is the source of truth. It's more liquid and stable than option prices.
- How? Set a price alert on your trading platform for the stock. When it triggers, manually evaluate and close the option if needed.
When Should You Use a Hard Stop?
Catastrophe Protection
If you're buying a speculative option for $5.00, you might set a Stop Loss at $1.00 just to save the last portion of your capital if the trade goes to near-zero. You aren't trying to manage the trade—you're just preventing a total wipeout while you're away from the screen.
The Bottom Line
A Stop Loss is a Blunt Instrument
In Stocks
🔪 A precise scalpel
In Options
🔨 A sledgehammer that often hits your thumb
Frequently Asked Questions
Summary
Don't let market noise steal your position.
- Stop losses in stocks: Reliable, precise protection.
- Stop losses in options: Often trigger on spread noise and volatility whipsaws.
- Better approach: Mental stops based on the underlying stock price, not the option price.
- Exception: Use hard stops only for catastrophe protection on speculative trades.
