When you place an option order, there are many types of orders and contingencies from which to choose. For example, there are market orders and limit orders, day and good-til-canceled, all-or-none and many others. Most traders are very familiar with these and they can greatly help your trading skills by making use of each of them under various conditions.
However, there is one type of order that is rarely talked about, in fact, it is even unknown by most brokers. It is called a whiplash order. It can be one of the most valuable option trading tools available to you.
Before we get into the whiplash order, it is important to understand the basic limit order.
A limit order is when you specify the price at which you are willing to buy or sell. For example, you can tell your broker to buy 10 contracts at a limit of $3. This means the order cannot be filled unless it is for $3 (or less). The drawback is that the order may never fill. Likewise, you can place an order to sell your contracts at a limit of $15; now your order will not fill unless you get $15 (or higher). Limit orders guarantee the price but not the execution.
One reason that options are so difficult to trade with limit prices is because the option is tied to an underlying stock. Many traders, especially with index options, like to sell their options when the stock or index hits a certain level. For example, say the OEX is trading at 725 and you hold 10 OEX Dec $730 calls. You want to sell them when the index hits 735. The question now is how much will the calls be worth?
Many traders often refer to the Black-Scholes Option Pricing Model to figure out what the limit price should be. The problem with this is that we do not know when the index will hit that level. If it happens quickly, the option will be worth much more than if happens over the course of a month. Further, we do not know what the implied volatility level will be. In short, we have no way to determine a good estimate.
So, what can a trader do?
This is where the whiplash order comes in handy. The trader in the above example could tell his broker to sell 10 $730 OEX calls When Level of Stock Hits 735, or WLSH = 735. The letters WLSH resemble a shortened version of the word "whiplash," hence the name. By the way, most brokerage firms will require whiplash orders to be at least 10 contracts.
Now, when the index hits 735, this order will become a market order and be sold. Keep in mind, this order does not guarantee a profit. Why? Say the trader paid $20 for the contract and the index hits $735 with only a few days to expiration; the call may only be $5 leaving the trader with a net loss of $15.
The WLSH order can be modified with a greater than (>) or less than (<) sign too. For example, a trader can instruct his broker to sell the contracts WLSH > 735 (or WLSH >= 735) or buy WLSH < 715.
You can get fancy and cross stocks or indices if you prefer. As some examples, you can sell your OEX calls when NDX hits a certain level. Likewise, you can sell your MSFT calls when the NDX hits a certain level or maybe buy INTC when MSFT goes below a certain level.
Crossing indices (or stocks) is probably not the best way to trade, but there may be certain circumstances where it may be warranted.
You should contact your broker to see if they handle whiplash orders or similar orders under a different name. They can be an invaluable tool for the option investor!