Not every investment ends up making a profit. It’s important to learn how to stop losses if your position doesn’t work out, or if the market takes an unexpected turn against you. Here, two helpful order types come in handy--stop market and stop limit. These two orders can be used to close positions at specific prices to protect your portfolio from further losses.

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Key Takeaways

• How do stop limit orders work for options holders?
  
• How do stop market orders work for options holders?
  
• The differences between stop limit and stop market orders.
  

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Trading Scenarios

Suppose you bought one call option on XYZ at $110, with a premium of $9.70. The contract is currently trading at $6.00. Unfortunately, the price of XYZ has been falling recently, causing your position to lose value. In this case, you may decide to place a stop market or stop limit order to limit possible losses.

• How Do Stop Limits Work for Options Holders？
  

To set a sell stop limit order, you must enter two prices: stop price and limit price. Suppose you set the stop price at $4.00, and the limit price at $3.00. If the price hits $4.00 or below, the order will be triggered and executed as a limit order, filled at no less than $3.00. However, if the contract price is out of the limit price range in a volatile market, the stop limit order may not be filled after being triggered.

Therefore, the stop limit order can be helpful if you want to have a certain filled price range when closing an options position.

• How Do Stop Market Orders Work for Options Holders？
  

To set a sell stop order, you only need to enter a stop price. Suppose you set the stop price at $4.00. If the price hits $4.00 or below, the order will be triggered and executed as a market order, with no guaranteed filled price. However, if the contract price drops suddenly when the order is triggered, the filled price may be far from your expected price.

From the example, if you want the order to be filled as soon as possible after it is triggered, a stop market would be more suitable than stop limit order, although it entails more risk.

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Stop Limit Vs. Stop Market

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Bottom Line

Stop orders are a powerful and helpful way to help you preserve profit and limit losses when opening and closing positions. Learning how to use investment tools and order types to protect your position can be highly beneficial for your investing practices.