Stop-loss
A stop-loss is a risk management tool used by traders to limit potential losses in a trade.
A stop-loss order is placed with the broker to buy or sell an option or a security when it reaches a specific price level, known as the stop price.
The main goal of a stop-loss order is to protect against significant losses in case the market moves unfavorably.
Example of stop-loss
Suppose you have entered an Iron Condor on SPX with a total credit of 2 dollars. You then set separate stop orders on the put credit spread and the call credit spread, each for 2 dollars. If the value of the put or call credit spread reaches 2 dollars, that part of the Iron Condor is automatically closed.
In this way your total loss on the Iron Condor will be zero, assuming that only the stop loss on one side triggered. You collected a total premium of 2 dollars and lost the same amount on the one stop-loss that triggered.
When to use a stop-loss
Stop-loss orders can be particularly useful in volatile markets, providing peace of mind by automating the exit strategy and ensuring that losses do not exceed a predetermined amount. They are essential tools for both novice and experienced traders looking to manage risk effectively.