We all have heard of using stop losses when trading stocks. Some teach them as something should always be in place while others teach stop losses as mental areas that one would consider taking a loss. In either case it is wise to some extent to use one or the other, but today we will show a different idea for those stock traders that want to use options as well.

One idea for using options for stop losses is to simply buy a put at some point under the current price of the underlying. For example, lets say you bought stock at $40 and that is where it is currently trading. You say if it trades under $35 then the trade is no longer valid and you wish to take a stop loss. One thing you can do is buy the $35 puts as protection from further falling prices. 

Using this approach will begin to cap your losses under $35 but this comes at a cost. If you spend $1, lets say on those puts then theoretically your average cost is now $41. If the stock never reaches $35 then eventually your put will become worthless and your "insurance" will expire.

Also if the stock heads higher then you will need to remember that you spent the $1 on the put options and factor that into any profit targets you may have.

Another thing you could do is to simply sell calls on the stock once you buy it and have a mental stop loss area. Let's use the same example from before. (If you bought stock at $40 and want to use the $35 area as a loss area.) In this case lets say you sold calls at $42 and collected $2. Now if the stock moves below $35 you will have a loss on the shares but will have gained as much as $2 profit on the calls making your potential loss only $3 instead of $5.

Now its important to note that the profit collected on the calls will vary depending on how close you are to expiration, volatility and other factors.

You also could choose to close the stock position and leave the short calls at this point though you will want to understand how your margin requirement will change.

These are just a few ways you can use options with a stop loss to limit those pesky trades that don't behave.