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"Placing Limit Order for Naked Put Write?"

Question By Tony Guzman

"Placing Limit Order for Naked Put Write?"

When writing a OTM cash-secured put, could you put a buy to close GTC limit order at for instance $0.03 and then forget about it and collect when it gets there?

Asked on 9 July 2011

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Answered by Mr. OppiE

Hi Tony,

Indeed, you could put a GTC (Good Till Cancelled) limit order in order to buy to close your naked put write at $0.03 as a profit taking point and then just forget about the position. However, the problem with this approach is that you are overly concerned with taking profit (as if the position is DEFINITELY going to be profitable) and forgetting your stop loss point.

A Naked Put Write is a limited profit, unlimited risk bullish options trading strategy. This means that it can accumulate losses indefinitely as long as the underlying stock keeps falling. This loss could come to a point where you will be required to top up margin to your options trading account in order to continue holding the position. As such, we should never do a naked put write without a stop loss method.

Herein lies the problem with using a limit order on your naked put write.

There are a few ways to place a stop loss on a naked put write, however, no matter which order you have in place as a stop loss order, a GTC limit order will automatically queue your position for closing at $0.03, overriding all your existing stop loss orders! That's right, when you use a limit order for profit taking, you are telling the broker to do nothing but try to close the position at this certain price which overrides all existing orders for that position. This means that if the underlying stock actually moves downwards instead of upwards and hits your stop loss point, nothing will be done and your naked put write position will continue to accumulate losses, which is extremely dangerous especially since you intend to "forget about it". This is why we always use proper orders to "Bracket" our position, one stop loss and one profit taking order.

So, what can we do in order to have both stop loss and profit taking orders for your naked put write without one overriding the other?

There are a few ways to do it but the neatest way is using what is known as a One-Cancel-Other (OCO) order. One-Cancel-Other order allows you to sell both a profit taking sell price and a stop loss sell price and have one cancel the other when either one is triggered first. This will take care of the conflict in orders and you can setup the order the moment the naked put write position is bought and truly "forget about it".

Example of Placing One-Cancel-Other Order for Naked Put Write

Assuming you wrote 1 contract of QQQ's $42 strike price put options when QQQ was trading at $44 for $0.50. You wish to take profit at $0.03 and stop loss at $1.50.

You could now put on a GTC One-Cancel-Other order with the following parameter:

Primary order: Buy To Close Limit $0.03 OCO GTC
Secondary order: Buy To Close Limit $1.50 OCO GTC

With this order in place, the position will be closed at market price when it reaches either $0.03 or $1.50, thereby fully automating your exit.

In conclusion, never forget your stop loss order even when you are full confident. Use a One-Cancel-Other order to bracket your position so that you could truly take your mind off your position and "forget about it".

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