Risk control is critical to any investment plan. Money management discipline is more difficult to employ successfully in volatile market conditions, even though it is often said that volatility equals opportunity.
The truth is, execution of buys or sells under extreme market conditions without using exit stop loss orders is a dangerous gamble, not an investment. The decision on where to place that stop is an artistic choice of a strategy that is hopefully far enough to allow market fluctuations, while still earning a reasonable dollar amount.
For traders, getting stopped out can be frustrating, though not being stopped out on a position that moves against them is often catastrophic.
An often overlooked trick that completely eliminates the use of stops while completing limiting and quantifying the risk is to use a call or put for protection instead.
Buying an option allows absolute risk control in even the most uncertain of markets. The option right to sell with a put protects a long position or a put protects a short position.
The option puts in a price floor below or a ceiling above that can be exercised anytime. The risk is the dollar difference between the entry price and that option strike.
Simply buying a put or call instead of an exit stop at an entry price provides risk control with staying power to ride through ups and downs.
An option is protection for a specific time period. This insurance has a cost in the premium paid. That cost can be offset by the peace of mind in a market meltdown, knowing that you can’t be forced out of the position by a short term move.
Use a put or call as protection and as a way to avoid being stopped out, while employing the risk control needed for money management discipline.
