Initiating an appropriate position is only one part of a trading strategy. Managing the option position’s risk is the other part. This week, we discuss whether it is optimal to apply trailing stop loss on your option positions. 

You typically apply two different kinds of stop loss to manage your trading positions. The first is to protect the downside risk of your position. This is applied when you initiate, say, a long position on a stock. The initial stop loss is to ensure that you do not lose a significant part of your capital allocated to this trade. The second type of stop loss is to protect your unrealised gains. This is the trailing stop loss. You could, for instance, use a two prior bar rule when you are managing a long stock position. This would be optimal when the stock is climbing but is yet to reach your price target. Previously, we discussed that your initial stop loss for option positions is best applied on the underlying price for equity options and on index futures price for index options. The question is: Can you apply trailing stop for your option positions?

An option derives its value from the underlying. The issue is that an option’s price is sensitive to not just the underlying price movement, but to its volatility and time to expiry. An increase in volatility of the underlying increases the option price; a decrease will have the opposite effect. This is captured by the option’s vega. An option also loses value with each passing day from time decay (theta). Accounting for these effects on the option price in addition to its movement with the underlying price (delta) and then designing an appropriate trailing stop loss may be quite challenging. For instance, an underlying can move up, but the option could lose value if the loss from time decay is greater than the gains from delta. In such cases, it may be better to take profits than holding the position with trailing stops. 

It is best to monitor your option position despite placing a trailing stop loss. This will require monitoring your position at least once during the first half of a trading day and then before market close. That way, you can decide to cancel your trailing stop and take profits if you believe the option price is stalling. Note that a trailing stop can be applied either as an absolute number (say 2.5 points) or as a percentage of the option price.

Optional Reading

Trailing stops can be challenging on spread trades. Take bull call spread. Suppose you initiate a trailing stop on the long call and on the short call. What if your long call is stopped and your short call becomes a naked position? Your margins will increase significantly. The point is that setting up a trailing stop should not lead to a sense of complacency about the position.

(The author offers training programmes for individuals to manage their personal investments)

Published on July 25, 2026