Sigh… WHY Would ANYone Still Use a Stop-Loss Order?

Well… I hate to say I told you so…

(that’s a d@mn lie… everybody that says “I told you so” says it with at least SOME relish…)

…but I have after all been saying for eight years now how important it is to use put options, specifically married puts with stock, to make a stop that REALLY works. An exit plan that actually behaves properly.

See, “stop” orders fail miserably at doing what they are intended to do: “STOP” the hemorrhaging when your stock goes against you, and keep you safe.

Feel safe? Did yesterday help? Of course I’m talking about the PLUNGE of Wall Street, in which it fell nearly 1000 points… 650 of those points in just a ten minute period. If you were trading with stops, the term “Black Swan” means something real to you now. That swan swooped in and TOOK you out of a position with a certain amount of pain, pain that you need never feel again.

So why use a put option to control your losses instead of a stop order? Here’s what stop orders really do: they leave you at the mercy of the lowest bidder and get you out at the worst possible price.

Most times, that’s just plain annoying… and I KNOW you’ve had this happen because I used to deal with it… the “stop” order you have in place gets filled as a stock vacillates. THEN, the stock gets a little moxy and heads for the moon. Only it does so without you. So your “stop” order has not only cost you commissions and capital losses… it also incurs the opportunity cost of taking you out of a good play just before it begins to win.

Other times, however, a “stop” order takes it to the dark side. If your stock is hammered hard in heavy volume, you can be sure that the price at which you set the stop will NOT be honored.

I once was long a stock at $38ish and the day after earnings it opened at less than $25. OUCH. Well, big ouch for some folks, little ouch for me because instead of a stop order I owned a put option.

Those other poor souls that were buying that stock on that day… and were thinking that a “stop” loss would STOP their LOSS… were sadly mistaken. A $38 stock with a 10% stop would mean that you’re only risking $3.80, right? Well, not with a sudden downturn. If the stock goes quickly to $25, or worse yet, GAPS at the open while you have a stop order in place… well, you get out at $25. That’s how the portfolio cookie crumbles.

The reason that I have advocated using a married put for eight years now is that your maximum possible loss is PREDEFINED… and if you do it MY way that predefined maximum risk is down in the single digit range. Plus you have absolute control. That means that YOU decide when, and IF, to exercise your put.

Know what happened with me yesterday when the market bounced so erratically? Well, after yawning and switching to the sports channel… mostly nothing. Why? Because my exit was already locked in and I had zero worries. IN fact, I placed a little bear call spread that actually added zero risk!

This was because I was both long on the stock and short on a call spread. If the stock goes down, my put and bear call spread gain in value. If the stock goes up, I’ve received a credit on the spread and get to add capital gains in the stock to that. An added bonus is that the increased VIX inflates the premium of my put option as well!

If you’ve been annoyed… or HURT… by the failings of stop orders… let me tell you that there is an alternative that solves BOTH of the worst problems. It’s the married put, applied properly and according to the principles of The Blueprint.

Happy Trading,

Kurt